Some Shareholders Feeling Restless Over Universal Music Group N.V.'s (AMS:UMG) P/E Ratio

Universal Music Group N.V.'s (AMS:UMG) price-to-earnings (or "P/E") ratio of 23.5x might make it look like a sell right now compared to the market in the Netherlands, where around half of the companies have P/E ratios below 19x and even P/E's below 11x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/E.

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With earnings growth that's superior to most other companies of late, Universal Music Group has been doing relatively well. It seems that many are expecting the strong earnings performance to persist, which has raised the P/E. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

See our latest analysis for Universal Music Group

Keen to find out how analysts think Universal Music Group's future stacks up against the industry? In that case, our free report is a great place to start.

Is There Enough Growth For Universal Music Group?

The only time you'd be truly comfortable seeing a P/E as high as Universal Music Group's is when the company's growth is on track to outshine the market.

Retrospectively, the last year delivered an exceptional 65% gain to the company's bottom line. The strong recent performance means it was also able to grow EPS by 133% in total over the last three years. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

Shifting to the future, estimates from the analysts covering the company suggest earnings growth is heading into negative territory, declining 2.5% per year over the next three years. That's not great when the rest of the market is expected to grow by 15% per annum.

With this information, we find it concerning that Universal Music Group is trading at a P/E higher than the market. It seems most investors are hoping for a turnaround in the company's business prospects, but the analyst cohort is not so confident this will happen. There's a very good chance these shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the negative growth outlook.

The Key Takeaway

We'd say the price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

Our examination of Universal Music Group's analyst forecasts revealed that its outlook for shrinking earnings isn't impacting its high P/E anywhere near as much as we would have predicted. When we see a poor outlook with earnings heading backwards, we suspect the share price is at risk of declining, sending the high P/E lower. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 1 warning sign with Universal Music Group, and understanding should be part of your investment process.

It's important to make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a low P/E).

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.