Take-Two (TTWO): Buy, Sell, or Hold Post Q1 Earnings?

Take-Two has had an impressive run over the past six months as its shares have beaten the S&P 500 by 22.2%. The stock now trades at $233.91, marking a 26.3% gain. This performance may have investors wondering how to approach the situation.

Is there a buying opportunity in Take-Two, or does it present a risk to your portfolio? Get the full stock story straight from our expert analysts, it’s free.

Why Is Take-Two Not Exciting?

Despite the momentum, we're cautious about Take-Two. Here are three reasons why we avoid TTWO and a stock we'd rather own.

1. Shrinking EBITDA Margin

Investors regularly analyze operating income to understand a company’s profitability. Similarly, EBITDA is a common profitability metric for consumer internet companies because it excludes various one-time or non-cash expenses, offering a better perspective of the business’s profit potential.

Looking at the trend in its profitability, Take-Two’s EBITDA margin decreased by 8.3 percentage points over the last few years. This raises questions about the company’s expense base because its revenue growth should have given it leverage on its fixed costs, resulting in better economies of scale and profitability. Its EBITDA margin for the trailing 12 months was 13.6%.

2. EPS Trending Down

Analyzing the change in earnings per share (EPS) shows whether a company's incremental sales were profitable – for example, revenue could be inflated through excessive spending on advertising and promotions.

Sadly for Take-Two, its EPS declined annually over the last three years while its revenue grew by 17.1%. This tells us the company became less profitable on a per-share basis as it expanded.

3. Cash Burn Ignites Concerns

Free cash flow isn't a prominently featured metric in company financials and earnings releases, but we think it's telling because it accounts for all operating and capital expenses, making it tough to manipulate. Cash is king.

While Take-Two posted positive free cash flow this quarter, the broader story hasn’t been so clean. Take-Two’s demanding reinvestments have consumed many resources over the last two years, contributing to an average free cash flow margin of negative 3.4%. This means it lit $3.39 of cash on fire for every $100 in revenue. This is a stark contrast from its EBITDA margin, and its investments (i.e., stocking inventory, building new facilities) are the primary culprit.

Final Judgment

Take-Two isn’t a terrible business, but it isn’t one of our picks. With its shares beating the market recently, the stock trades at 19.7× forward EV/EBITDA (or $233.91 per share). This valuation tells us a lot of optimism is priced in - you can find more timely opportunities elsewhere. We’d recommend looking at the most dominant software business in the world.

Stocks We Would Buy Instead of Take-Two

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