Universal Music Group N.V.'s (AMS:UMG) Fundamentals Look Pretty Strong: Could The Market Be Wrong About The Stock?

Universal Music Group (AMS:UMG) has had a rough month with its share price down 5.4%. However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. Specifically, we decided to study Universal Music Group's ROE in this article.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

We've discovered 2 warning signs about Universal Music Group. View them for free.

How To Calculate Return On Equity?

The formula for return on equity is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Universal Music Group is:

46% = €2.1b ÷ €4.6b (Based on the trailing twelve months to December 2024).

The 'return' is the yearly profit. That means that for every €1 worth of shareholders' equity, the company generated €0.46 in profit.

View our latest analysis for Universal Music Group

Why Is ROE Important For Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

A Side By Side comparison of Universal Music Group's Earnings Growth And 46% ROE

First thing first, we like that Universal Music Group has an impressive ROE. Secondly, even when compared to the industry average of 15% the company's ROE is quite impressive. Probably as a result of this, Universal Music Group was able to see a decent net income growth of 12% over the last five years.

Next, on comparing Universal Music Group's net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 12% over the last few years.

Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Has the market priced in the future outlook for UMG? You can find out in our latest intrinsic value infographic research report.

Is Universal Music Group Making Efficient Use Of Its Profits?

While Universal Music Group has a three-year median payout ratio of 79% (which means it retains 21% of profits), the company has still seen a fair bit of earnings growth in the past, meaning that its high payout ratio hasn't hampered its ability to grow.

Moreover, Universal Music Group is determined to keep sharing its profits with shareholders which we infer from its long history of three years of paying a dividend. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 53% over the next three years. However, Universal Music Group's future ROE is expected to decline to 37% despite the expected decline in its payout ratio. We infer that there could be other factors that could be steering the foreseen decline in the company's ROE.

Summary

In total, we are pretty happy with Universal Music Group's performance. Especially the high ROE, Which has contributed to the impressive growth seen in earnings. Despite the company reinvesting only a small portion of its profits, it still has managed to grow its earnings so that is appreciable. That being so, according to the latest industry analyst forecasts, the company's earnings are expected to shrink in the future. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.