What happened

Shares of Unity Software (NYSE:U) lost 28.2% in value last month, according to data provided by S&P Global Market Intelligence

The leading software platform for gaming and 3D content delivered record revenue for the fourth quarter of 2020, but it wasn't enough to justify a richly valued stock price

A chart showing a falling stock price.

Image source: Getty Images.

So what

Unity Software reported revenue of $220 million, up 39% year over year. But investors were likely more focused on the deceleration in revenue growth over previous quarters, where fourth-quarter growth was below the full-year increase of 43%. 

On the bright side, profitability is improving. It's normal for fast-growing companies to sacrifice near-term profits for long-term growth, but management's goal is to move the business toward free-cash-flow breakeven. It's already showing some progress based on other metrics, with full-year adjusted operating loss improving from $91.8 million in 2019 to $50.6 million in 2020. 

Now what

Management's outlook for 2021 overshadowed the improvement on the bottom line. Guidance calls for full-year revenue to come in between $950 million and $970 million. That represents year-over-year growth of just 24% at the midpoint, which raises concerns about Unity's valuation.

Unity completed its initial public offering last year and rocketed to a high price-to-sales ratio of around 50, which implies very high growth expectations. But with revenue growth decelerating, investors have recalibrated their expectations. The stock now trades at 30 times trailing revenue.

U PS Ratio Chart

U PS Ratio data by YCharts

Still, investors should keep this one on their watchlist. Unity is the world's leading software platform for operating mobile games and other interactive content. It hit record levels of monthly active users on its platform in the fourth quarter as Unity gained market share among the top 1,000 games that rely on its software. 

The backdrop of a growing video game industry is a nice tailwind to drive returns over time, but Unity is also positioning its platform to grow beyond just making games, which sweetens the opportunity.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.