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Unity Software Inc(U-N)

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Why Unity Software Stock Died Friday Morning -- Then Got Better

Motley Fool - Fri Nov 10, 2023

Shares of 3D virtual reality company Unity Software (NYSE: U) plunged 12% at the open on Friday after reporting an earnings miss Thursday evening.

Heading into Q3, analysts had forecast Unity would earn $0.17 per share on $553.7 million in sales. Instead, Unity reported a $0.32 per share loss, and its sales fell short of expectations at just $544.2 million.

That sounds like bad news, and explains the steep early sell-off at Unity. On the plus side, the stock already seems to be recovering somewhat, and as of 10:05 a.m. ET Unity is down only 3.3%.

Unity Software sales and earnings

And yet the news wasn't all bad. As Unity Software pointed out, its revenues may have missed estimates, and "we believe we can do better." Nevertheless, Unity did still grow its sales 69% year over year, which...isn't too shabby.

Similarly, while management failed to deliver Wall Street's expected profit, it did cut its losses in half from the year-ago quarter. Net losses fell from $250 million to $125 million per generally accepted accounting principles (GAAP). And the negativity of the company's net profit margin improved significantly, from negative 77% a year ago to negative 23% this time around.

And while that's still a negative number for accounting earnings, Unity Software delivered positive free cash flow of $104 million for the quarter.

Should you buy Unity Software stock?

This means that Unity effectively flipped from burning cash to generating cash profit in Q3. And while management did not provide guidance through the end of this year, year to date, the company has generated $118 million in positive free cash flow, according to data from S&P Global Market Intelligence. If this trend continues, the company might generate as much as $157 million in free cash flow this year -- and deliver its first full year of positive free cash flow ever.

Admittedly, at a current-year valuation of more than 61 times free cash flow, the stock isn't obviously cheap. Still, analysts polled by S&P think Unity Software will double its free-cash-flow number next year, then nearly double it again in 2025 -- putting the company at about $590 million in cash generation that year.

This would drop the stock's valuation down to about 16 times 2025 free cash flow, and -- in my opinion at least -- make it cheap enough to buy on even modest growth rates thereafter.

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Rich Smith has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Unity Software. The Motley Fool has a disclosure policy.

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