Universal Music Group N.V.'s (AMS:UMG) Has Had A Decent Run On The Stock market: Are Fundamentals In The Driver's Seat?

Universal Music Group's (AMS:UMG) stock up by 7.2% over the past three months. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to investigate if the company's decent financials had a hand to play in the recent price move. Specifically, we decided to study Universal Music Group's ROE in this article.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

Check out our latest analysis for Universal Music Group

How Do You Calculate Return On Equity?

The formula for ROE is:

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

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

45% = €1.6b ÷ €3.5b (Based on the trailing twelve months to June 2024).

The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each €1 of shareholders' capital it has, the company made €0.45 in profit.

What Has ROE Got To Do With Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

Universal Music Group's Earnings Growth And 45% ROE

Firstly, we acknowledge that Universal Music Group has a significantly high ROE. Additionally, the company's ROE is higher compared to the industry average of 14% which is quite remarkable. Probably as a result of this, Universal Music Group was able to see a decent net income growth of 5.1% over the last five years.

We then compared Universal Music Group's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 20% in the same 5-year period, which is a bit concerning.

Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. What is UMG worth today? The intrinsic value infographic in our free research report helps visualize whether UMG is currently mispriced by the market.

Is Universal Music Group Using Its Retained Earnings Effectively?

The high three-year median payout ratio of 79% (or a retention ratio of 21%) for Universal Music Group suggests that the company's growth wasn't really hampered despite it returning most of its income to its shareholders.

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. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 59% over the next three years. Still forecasts suggest that Universal Music Group's future ROE will drop to 35% even though the the company's payout ratio is expected to decrease. This suggests that there could be other factors could driving the anticipated decline in the company's ROE.

Summary

In total, it does look like Universal Music Group has some positive aspects to its business. Its earnings growth is decent, and the high ROE does contribute to that growth. However, investors could have benefitted even more from the high ROE, had the company been reinvesting more of its earnings. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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.