Take-Two Interactive Software Inc. (NASDAQ:TTWO) is finally having its moment in the sun, after peaking in stock price over 10 years ago. With its recent run-up in price over the last month due to a strong earnings report, the stock has reclaimed its 10-year price highs. On Friday, the stock gained a shade under 4% after analysts at Bank of America raised their price target on the company to $32. This article will be a comprehensive bottom-up analysis of Take-Two Interactive, specifically looking at its valuation and growth profile. By looking at certain value and growth factors that have generated alpha in the past, our algorithms estimate the alpha a stock will generate in the future. Besides valuation and growth, we also will look at how the "smart money" on the street (i.e. company insiders, institutions, and shorts) is transacting the stock and how the company has been performing recently relative to analyst earnings expectations.
Let us first start with an analysis of Take-Two's overall growth profile, looking at five growth metrics that have been repeatedly shown to predict stock returns. This is shown below:
Take-Two has been strongly outperforming its industry group, sector and overall market in each of the five growth metrics shown above. Take-Two's stock price has gained 36% in the last 6-months and 71% in the last twelve, way above the average software stock (6% and 9%) and average technology stock (3% and 11%). On the financial side, TTWO grew annual EPS numbers by 989%, way above the average EPS gain of 18% in the Software group and 4% of the technology sector. TTWO was extremely efficient as well, returning 54% on equity and 24% on assets. In every single metric, TTWO was ranked in the top 10% of the overall market. In terms of price momentum, EPS growth and efficiency, you'd be hard pressed to find a better growth profile for a stock. Based on its respective strength in each of these growth metrics and average excess returns generated by these factors, our algorithms expect Take-Two to generate 8.6% of "growth oriented" outperformance over the upcoming 12 months.
Next, we'll see if there is any outperformance to be generated by Take-Two's valuation profile, again comparing them on an absolute and relative basis. Similar to the growth breakdown, we again look at five metrics that have been repeatedly shown to predict stock returns. These are shown below:
Take-Two is undervalued relative to the software industry group, technology sector, and overall market. Take-Two's sales yield of 98% (sales yield is the inverse of Price/Sales ratio) means that an investor can currently get $0.98 in revenue for every $1 they invest in the stock. This is wildly higher than the average software stock (12%) and average technology stock (23%). Take-Two looks relatively undervalued on an earnings basis as well, with its earnings yield of 8.1% being much higher than both the software average (0.82%) and technology stock average (1.4%). Additionally, Take-Two's Price-to-Book (2.99) and Price-to-FCF (5.98) look reasonably cheap, with both representing significant discounts relative to the software and technology average. Our algorithms expect Take-Two to generate 7.1% of "value oriented" outperformance (i.e. alpha) over the upcoming 12-months.
Next, we'll look at how Take-Two's earnings have been performing relative to analyst expectations. We've found through extensive back testing that stocks that beat analyst estimates are much more likely to keep beating analyst estimates. This is key for investors who plan to hold stocks through quarterly earning releases, as stocks experience massive swings in price depending on their results. Take-Two's earnings history is shown below:
Take-Two has a history of crushing EPS estimates, extending its streak of consecutive EPS beats to nine after its 8.33% surprise last quarter. Additionally, the stock beat last quarter revenue estimates by 21% and has beaten top-line results in eight of the last ten quarters. Our earnings model gives them a perfect 5-star rating, and projects a very high probability of them beating EPS estimates again next quarter. The Wall Street Consensus is calling for $-0.48 in quarterly EPS and $112 million in sales, and they are expected to report next on February 2nd, 2015.
E) Other Key Metrics to Watch
Although our algorithms do not factor the following metrics into our overall alpha predictions, there is academic evidence showing that they predict stock returns as well. They are shown below:
Take-Two has been experiencing modest insider (+2.4%) and institutional (+3.9%) increases in ownership over the last few months, reflecting moderate accumulation from two "smart money" players. On the other hand, short interest is high for the stock, representing over 17% of the total float. It should also be mentioned that the Take-Two's valuation is less attractive on a forward-looking basis (5% earnings yield). In the short-term, Take-Two's 14-day RSI is slightly elevated, making the stock slightly more vulnerable to a short-term pullback.
Take-Two Interactive combines solid price momentum, profit growth and financial efficiency with an attractive relative valuation. We believe the stock will generate 15.71% of outperformance over the market, with 8.57% owing to its growth profile and 7.14% coming from its relative undervaluation. To come up with a price target, we need to analyze market-based returns (i.e. beta) as well. Take-Two's current beta is 1.53, so if one assumes the market returns 7.5% over the next year (its historical average), then you get an expected market-based return of 11.48% (1.53 * 7.5%). Finally, we times the current price by the sum of the market-based return (beta) and expected 12-month outperformance (alpha):
$27.05 * (1 + 11.48% + 15.71%) = $34.40
This represents upside of 27% from its current price, and is $3.47 ahead of the Bank of America price target.
We feel the software industry group is overvalued on the whole, but two other names that are worthy of further research include:
Net 1 Ueps Technologies (NASDAQ:UEPS) - Price Target of $12.94 (+23%)
Ebix Inc. (NASDAQ:EBIX) - Price Target of $19.25 (+20%)
King Digital Entertainment (BATS:KING) and EnerNOC Inc. (NASDAQ:ENOC) also are interesting names in this industry, though our algorithms are much more mixed on their prospects. King looks undervalued on an earnings basis and has a great ROE and ROA, though this is countered by horrible recent price performance. ENOC looks relatively undervalued as well, though recent price momentum has been weak.
Disclosure: The author is long TTWO.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.