The past year has not been kind to tech stock investors. The Nasdaq Composite index is 20% off its all-time high, but even that much damage is not entirely reflective of the pain many investors in the tech space have felt. Despite remaining strong financially and operationally, dozens of technology companies are down more than 40% from their all-time highs.
Upstart Holdings (UPST -3.65%) and Unity Software (U -4.20%) are both in this group, falling 81% and 62%, respectively, from their all-time highs even though the companies are seeing impressive adoption rates and financial improvements. Nevertheless, because they both have durable advantages in their respective markets, you might want to consider loading up on these companies while they are still cheap.
Disruptors can be riskier investments because of the uphill battle these companies face. But once they start seeing strong adoption at a large scale, it can signal a great buying opportunity for long-term investors to get in on the next top dog in its sector. That's where I see Upstart today in the U.S. loan industry.
Many large banks determine creditworthiness based on just a handful of variables and rely heavily on Fair Isaac's (FICO 0.77%) FICO credit scores, but this can be flawed. Most Americans have never defaulted on borrowing, yet only 48% have a prime credit rating.
Upstart is changing this by using artificial intelligence to analyze 1,500 variables and over 21 million repayment events to paint a more accurate picture of an applicant's creditworthiness.
The company partners with banks to give these credit ratings, which provides a unique balance of benefits. It can provide access to prime credit to more Americans while taking on barely any credit risk: 94% of its revenue has zero credit exposure.
Upstart is trying to disrupt the credit-rating business because of its flaws, and it is seeing success so far. The company made determinations on nearly 500,000 loans in the fourth quarter of 2021 alone, a 302% increase year over year. Because it earns money from each loan originated, it has seen major top-line growth. In 2021, revenue reached $849 million, which skyrocketed 264% year over year.
What's remarkable about Upstart is its ability to achieve profitability while growing rapidly. In 2021, net income reached $135 million and its free cash flow surpassed $153 million. The company is guiding for 2022 revenue of $1.4 billion, an increase of 65% year over year. However, investors might not be pricing in any of this projected success: Upstart trades at just around 8.4 times sales.
While the company has yet to withstand a full credit cycle and we have only seen its performance during a booming economic period, investors might want to take on a little risk with this impressive disruptor.
2. Unity Software
Unity is similar to Upstart in that it is seeing rapid adoption in a massive industry, video game development. Its market-leading products help developers build, operate, and monetize video games.
The company says that 50% of all mobile, PC, and console video games were made with its software in 2019. It now reports more than 1.5 million monthly active creators on its platform, and its market dominance is likely even higher.
As a result of this dominance, Unity has been able to grow rapidly. In 2021, revenue reached $1.1 billion, a 44% increase year over year. Importantly, developers are becoming more reliant on its services to thrive. At the end of 2021, the company's net expansion rate reached 140%. And more than 1,050 customers were spending more than $100,000 on the platform in 2021, a total that jumped 33% year over year. As customers continue to rely on Unity, it will only strengthen its leadership and solidify its status as the platform to develop video games.
Unity is quickly becoming the gold standard for graphics and visualization. The company recently acquired two small businesses -- Ziva Dynamics and Weta Digital -- that produce some of the best visual effects in the industry, which will now be available to Unity customers. This means that it can offer top-tier graphics capabilities, making it a no-brainer for new developers.
One big risk for Unity, however, is its cash burn. Last year, the company burned $153 million in free cash flow, worsening from $20 million in 2020. This poses a major risk: If the company continues to burn cash, it will eventually have to dilute shareholders by raising capital. That being said, that could be a long way off since the company had more than $1.7 billion in cash and securities on its balance sheet at the end of 2021.
Because of this, along with its high valuation in late 2021, shares have fallen to a bargain price. The stock recently traded at 19 times sales, the lowest valuation Unity has ever seen as a public company. Because of the dominance that could continue to help it climb, it's worth considering adding this disruptive company to your portfolio at its cheapest valuation in history.