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Universal Music Group N.V.'s (AMS:UMG) price-to-earnings (or "P/E") ratio of 50.9x might make it look like a strong sell right now compared to the market in the Netherlands, where around half of the companies have P/E ratios below 16x and even P/E's below 9x are quite common. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's so lofty.
Universal Music Group hasn't been tracking well recently as its declining earnings compare poorly to other companies, which have seen some growth on average. One possibility is that the P/E is high because investors think this poor earnings performance will turn the corner. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.
Check out our latest analysis for Universal Music Group
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Is There Enough Growth For Universal Music Group?
The only time you'd be truly comfortable seeing a P/E as steep as Universal Music Group's is when the company's growth is on track to outshine the market decidedly.
Retrospectively, the last year delivered a frustrating 12% decrease to the company's bottom line. As a result, earnings from three years ago have also fallen 20% overall. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.
Shifting to the future, estimates from the analysts covering the company suggest earnings should grow by 31% each year over the next three years. With the market only predicted to deliver 9.2% per year, the company is positioned for a stronger earnings result.
In light of this, it's understandable that Universal Music Group's P/E sits above the majority of other companies. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.
The Final Word
Typically, we'd caution against reading too much into price-to-earnings ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.
As we suspected, our examination of Universal Music Group's analyst forecasts revealed that its superior earnings outlook is contributing to its high P/E. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. Unless these conditions change, they will continue to provide strong support to the share price.
It is also worth noting that we have found 2 warning signs for Universal Music Group (1 doesn't sit too well with us!) that you need to take into consideration.