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Is Take-Two Interactive Software, Inc.’s (NASDAQ:TTWO) High P/E Ratio A Problem For Investors?

This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We’ll show how you can use Take-Two Interactive Software, Inc.’s (NASDAQ:TTWO) P/E ratio to inform your assessment of the investment opportunity. Based on the last twelve months, Take-Two Interactive Software’s P/E ratio is 54.27. That is equivalent to an earnings yield of about 1.8%.

Check out our latest analysis for Take-Two Interactive Software

How Do I Calculate Take-Two Interactive Software’s Price To Earnings Ratio?

The formula for price to earnings is:

Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)

Or for Take-Two Interactive Software:

P/E of 54.27 = $102.1 ÷ $1.88 (Based on the trailing twelve months to September 2018.)

Is A High P/E Ratio Good?

A higher P/E ratio implies that investors pay a higher price for the earning power of the business. That isn’t a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business’s prospects, relative to stocks with a lower P/E.

How Growth Rates Impact P/E Ratios

Earnings growth rates have a big influence on P/E ratios. When earnings grow, the ‘E’ increases, over time. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.

Notably, Take-Two Interactive Software grew EPS by a whopping 52% in the last year. And its annual EPS growth rate over 3 years is 114%. So we’d generally expect it to have a relatively high P/E ratio. Unfortunately, earnings per share are down 1.1% a year, over 5 years.

How Does Take-Two Interactive Software’s P/E Ratio Compare To Its Peers?

The P/E ratio indicates whether the market has higher or lower expectations of a company. You can see in the image below that the average P/E (21.7) for companies in the entertainment industry is lower than Take-Two Interactive Software’s P/E.

NasdaqGS:TTWO PE PEG Gauge December 21st 18
NasdaqGS:TTWO PE PEG Gauge December 21st 18

Its relatively high P/E ratio indicates that Take-Two Interactive Software shareholders think it will perform better than other companies in its industry classification. Shareholders are clearly optimistic, but the future is always uncertain. So further research is always essential. I often monitor director buying and selling.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

It’s important to note that the P/E ratio considers the market capitalization, not the enterprise value. In other words, it does not consider any debt or cash that the company may have on the balance sheet. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.

Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.

How Does Take-Two Interactive Software’s Debt Impact Its P/E Ratio?

The extra options and safety that comes with Take-Two Interactive Software’s US$1.0b net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.

The Verdict On Take-Two Interactive Software’s P/E Ratio

Take-Two Interactive Software’s P/E is 54.3 which is way above average (16.1) in the US market. Its net cash position supports a higher P/E ratio, as does its solid recent earnings growth. Therefore it seems reasonable that the market would have relatively high expectations of the company

Investors have an opportunity when market expectations about a stock are wrong. People often underestimate remarkable growth — so investors can make money when fast growth is not fully appreciated. So this free visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.

You might be able to find a better buy than Take-Two Interactive Software. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.

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