One of Wall Street's biggest winners of the day is Warner Music, a entertainment company whose shares have climbed 14.1% to a price of $30.79 -- near its average analyst target price of $32.18.
The average analyst rating for the stock is buy. WMG may have outstripped the S&P 500 index by 12.9% so far today, but it has lagged behind the index by 19.9% over the last year, returning -35.7%.
Warner Music Group Corp. operates as a music entertainment company in the United States, the United Kingdom, Germany, and internationally. The company is included within the communication services sector, which generally includes cyclical companies whose share prices rise and fall along with macro economic cycles. One exception are telecommunications providers, which are more akin to utilities in that demand for their services remain somewhat consistent regardless of the state of the economy.
Warner Music's trailing 12 month P/E ratio is 37.5, based on its trailing Eps of $0.82. The company has a forward P/E ratio of 32.1 according to its forward Eps of $0.96 -- which is an estimate of what its earnings will look like in the next quarter.
As of the third quarter of 2022, the average Price to Earnings (P/E) ratio for US communication services companies is 18.65, and the S&P 500 has an average of 15.97. The P/E ratio consists in the stock's share price divided by its earnings per share (Eps), representing how much investors are willing to spend for each dollar of the company's earnings. Earnings are the company's revenues minus the cost of goods sold, overhead, and taxes.
The main limitation with P/E ratios is that they don't take into account the growth of earnings. This means that a company with a higher than average P/E ratio may still be undervalued if it has high projected earnings growth. Conversely, a company with a low P/E ratio may not present a good value proposition if its projected earnings are stagnant.
When we divide Warner Music's P/E ratio by its projected 5 year earnings growth rate, we obtain its Price to Earnings Growth (PEG) ratio of 0.86. Since a PEG ratio of 1 or less may indicate that the company's valuation is proportionate to its growth potential, we see here that investors are undervaluing WMG's growth potential .
To gauge the health of Warner Music's underlying business, let's look at gross profit margins, which are the company's revenue minus the cost of goods only. Analyzing gross profit margins gives us a good picture of the company's pure profit potential and pricing power in its market, unclouded by other factors. As such, it can provide insights into the company's competitive advantages -- or lack thereof.
WMG's average gross profit margins over the last four years are 47.0%, which indicate it has a potential competitive advantage in its market. These margins have slightly increased over the last four years, with an average growth rate of 1.8%. Warner Music's financial viability can also be assessed through a review of its free cash flow trends. Free cash flow refers to the company's operating cash flows minus its capital expenditures, which are expenses related to the maintenance of fixed assets such as land, infrastructure, and equipment. Over the last four years, the trends have been as follows:
| Date Reported | Cash Flow from Operations ($) | Capital expenditures ($) | Free Cash Flow ($) | YoY Growth (%) |
|---|---|---|---|---|
| 2021-09-30 | 638,000,000.0 | -93,000,000.0 | 545,000,000.0 | 44.18 |
| 2020-09-30 | 463,000,000.0 | -85,000,000.0 | 378,000,000.0 | 27.7 |
| 2019-09-30 | 400,000,000.0 | -104,000,000.0 | 296,000,000.0 | -15.67 |
| 2018-09-30 | 425,000,000.0 | -74,000,000.0 | 351,000,000.0 | n/a |
- Average free cash flow: $392,500,000.00
- Average free cash flown growth rate: 18.7 %
- Coefficient of variability (lower numbers indicating more stability): 27.3 %
With its positive cash flow, the company can not only re-invest in its business, it can offer regular returns to its equity investors in the form of dividends. Over the last 12 months, investors in WMG have received an annualized dividend yield of 2.2% on their capital.
Value investors often analyze stocks through the lens of its Price to Book (P/B) Ratio (market value divided by book value). The book value refers to the present value of the company if the company were to sell off all of its assets and pay all of its debts today - a number whose value may differ significantly depending on the accounting method.
Warner Music's P/B ratio indicates that the market value of the company exceeds its book value by a factor of 101, so the company's assets may be overvalued compared to the average P/B ratio of the Communication Services sector, which stands at 2.62 as of the third quarter of 2022.
Warner Music is by most measures fairly valued because it has an inflated P/E ratio, an elevated P/B ratio, and a steady stream of strong cash flows with an upwards trend. The stock has strong growth indicators because it has a a PEG ratio of less than 1 and consistently strong gross margins that are increasing. We hope you enjoyed this overview of WMG's fundamentals.
