The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We’ll look at Take-Two Interactive Software, Inc.’s (NASDAQ:TTWO) P/E ratio and reflect on what it tells us about the company’s share price. Looking at earnings over the last twelve months, Take-Two Interactive Software has a P/E ratio of 29.06. That means that at current prices, buyers pay $29.06 for every $1 in trailing yearly profits.
How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Take-Two Interactive Software:
P/E of 29.06 = $94.11 ÷ $3.24 (Based on the trailing twelve months to December 2018.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that buyers have to pay a higher price for each $1 the company has earned over the last year. That isn’t necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. When earnings grow, the ‘E’ increases, over time. And in that case, the P/E ratio itself will drop rather quickly. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Take-Two Interactive Software’s 91% EPS improvement over the last year was like bamboo growth after rain; rapid and impressive. On the other hand, the longer term performance is poor, with EPS down 5.4% per year over 5 years.
How Does Take-Two Interactive Software’s P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. The image below shows that Take-Two Interactive Software has a higher P/E than the average (23.2) P/E for companies in the entertainment industry.
Take-Two Interactive Software’s P/E tells us that market participants think the company will perform better than its industry peers, going forward. Clearly the market expects growth, but it isn’t guaranteed. So further research is always essential. I often monitor director buying and selling.
Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits
The ‘Price’ in P/E reflects the market capitalization of the company. That means it doesn’t take debt or cash into account. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).
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.
So What Does Take-Two Interactive Software’s Balance Sheet Tell Us?
Take-Two Interactive Software has net cash of US$1.6b. This is fairly high at 16% of its market capitalization. That might mean balance sheet strength is important to the business, but should also help push the P/E a bit higher than it would otherwise be.
The Bottom Line On Take-Two Interactive Software’s P/E Ratio
Take-Two Interactive Software’s P/E is 29.1 which is above average (18.2) in the US market. The excess cash it carries is the gravy on top its fast EPS growth. So based on this analysis we’d expect Take-Two Interactive Software to have a high P/E ratio.
Investors have an opportunity when market expectations about a stock are wrong. As value investor Benjamin Graham famously said, ‘In the short run, the market is a voting machine but in the long run, it is a weighing machine.’ 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.
Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.