The market has been turbulent in recent months, and investors have been quick to sell out of software stocks with growth-dependent valuations amid a rising tide of risk factors. While volatility and uncertainty are stressful, these conditions also create opportunities. Many growth stocks with the potential to deliver multibagger returns over the long term have seen their valuations depressed and are worth pouncing on today.
One of those growth stocks, Unity Software (U -0.38%), has seen its share price fall roughly 60% from the lifetime high it reached last November, and the stock has what it takes to deliver market-crushing returns. Here's why I believe investing in the content-creation specialist will have big payoffs.
Unity is paving the way for the next generation of media
Unity's software for creating 3D content, video games, and special effects has it positioned to play an important role in the future of visual content. According to management's last quarterly update, more than 71% of the top 1,000 mobile games relied on Unity's software.
When Activision Blizzard was mapping out how to bridge its hugely successful Call of Duty franchise to mobile platforms, it selected Unity's development engine as the foundation for the project.
While Activision Blizzard won't need to worry as much about near-term earnings performance once it's integrated into Microsoft and may increasingly opt to build its own engines, the fact that a company with substantial resources and development and design expertise opted to go with Unity's engine for one of its most important titles speaks to the value of Unity's services.
The company says its software is already used to create more than two-thirds of augmented reality (AR) and virtual reality (VR) experiences, and it's on track to benefit from the expansion of metaverses and interactive content. Some analysts and industry experts anticipate that the metaverse will eventually go on to become a multi-trillion-dollar annual market.
The company is also rolling out new visual-art creation services aimed at making advanced tools available to a whole new audience of creators. Unity's moves to purchase Weta Digital and other special-effects studios and cloud-based collaboration software providers, including Interactive Data Visualization and Ziva Dynamics, have put the business in a great position to expand its product offerings and build out new growth drivers.
Invest in a fantastic growth engine at a discount
Net revenue retention is a key metric for software-as-a-service (SaaS) companies because it tracks how much customers are increasing their spending on their services. Check out the chart below for Unity's net revenue expansion rate over its last six reported quarters.
Unity's net revenue expansion rate has been absolutely phenomenal in its recent history. With a net revenue expansion rate of 140% in the fourth quarter, that means customers who were already using its platform boosted their spending on its services by 40% compared to the prior-year period.
The combination of net revenue expansion and new customer additions has created a powerful growth engine.
Between attracting new customers and benefiting from increased spending from existing clients, Unity grew revenue 44% last year to reach $1.1 billion, and the business posted a non-GAAP (adjusted) gross margin of 80%. On the heels of last year's strong growth, the company is guiding for sales growth between 34% and 36% this year and expects margins to improve.
Unity now has a market capitalization of roughly $26 billion and is valued at approximately 17.5 times this year's expected sales. Strong net revenue retention rates and customer addition numbers show that Unity is providing valuable services and point to explosive long-term growth potential.