Gaming manufacturer and developer, Aristocrat Leisure Limited (ASX: ALL) is sitting near a 52-week high after gains of around 75% in the last year, outshining all but a few of the S&P/ASX 100 (Index: ^AXTO) (ASX: XTO) members.
In recent years, Aristocrat has been focusing on online opportunities for further growth, most notably with the acquisition of Video Gaming Technologies.
Aristocrat is well run, generating a return on equity of 27% and investors have been rewarded with average annual returns of 51% over the last five years.
A P/E ratio of 27 suggests it is still priced as a growth stock. This is not without good reason – net profits doubled in the last year. However, further growth will be required in the next few years to justify the current earnings multiple.
Analysts have forecast earnings per share of 70 cents for 2017 and a dividend of 32.3 cents per share, implying a forward P/E of 22.6 and a yield of around 2%.
The P/E ratio is of limited use without also considering the growth rate. A P/E growth ratio (PEG) of below 1 is an indication that a stock may be cheap relative to its growth.
Commsec currently calculates a PEG of 0.57, on the basis of a P/E ratio of 27 and a growth rate of nearly 50%. This suggests that Aristocrat is currently still cheaper than most large cap stocks in relation to its growth potential.
Although a low PEG ratio can be an indicator of value, it is also a sign that the market is pricing in the risk that the high rate of growth will not continue in the future.
In my view, unless investors are confident that Aristocrat can continue to make significant acquisitions that contribute to further growth, they may be better off waiting for a better entry point.
On the plus side, Aristocrat generates just 20% of revenues from Australia and New Zealand, with the majority coming from the US. This means any further weakness in the Australian dollar would be a boost for its bottom line.
However, investors should be aware that last month, media reports revealed a potential class action lawsuit to be led by Maurice Blackburn claiming that some of Aristocrat's poker machines are misleading and deceptive. It appears the market is not too worried about this, as its shares have continued to trade higher.
Whether or not a lawsuit has an impact on Aristocrat, given the industry it operates in, it may not be everyone's idea of an ethical investment.
