Universal Music Group N.V.'s (AMS:UMG) Business Is Trailing The Market But Its Shares Aren't

With a price-to-earnings (or "P/E") ratio of 41.8x Universal Music Group N.V. (AMS:UMG) may be sending very bearish signals at the moment, given that almost half of all companies in the Netherlands have P/E ratios under 17x and even P/E's lower than 10x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.

Universal Music Group certainly has been doing a good job lately as it's been growing earnings more than most other companies. The P/E is probably high because investors think this strong earnings performance will continue. If not, then existing shareholders might be a little nervous about the viability of the share price.

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What Are Growth Metrics Telling Us About The High P/E?

In order to justify its P/E ratio, Universal Music Group would need to produce outstanding growth well in excess of the market.

Retrospectively, the last year delivered an exceptional 60% gain to the company's bottom line. Despite this strong recent growth, it's still struggling to catch up as its three-year EPS frustratingly shrank by 8.6% overall. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

Looking ahead now, EPS is anticipated to climb by 15% per annum during the coming three years according to the analysts following the company. Meanwhile, the rest of the market is forecast to expand by 13% per year, which is not materially different.

With this information, we find it interesting that Universal Music Group is trading at a high P/E compared to the market. Apparently many investors in the company are more bullish than analysts indicate and aren't willing to let go of their stock right now. Although, additional gains will be difficult to achieve as this level of earnings growth is likely to weigh down the share price eventually.

The Final Word

Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.

Our examination of Universal Music Group's analyst forecasts revealed that its market-matching earnings outlook isn't impacting its high P/E as much as we would have predicted. When we see an average earnings outlook with market-like growth, we suspect the share price is at risk of declining, sending the high P/E lower. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

Having said that, be aware Universal Music Group is showing 1 warning sign in our investment analysis, you should know about.

If P/E ratios interest you, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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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.