With the Nasdaq Composite up 35% this year, it's getting harder to find bargains in the tech sector. Unity Software (U +0.23%) stock has rebounded 53% year to date but is still almost 80% off its peak, despite the company reporting significantly higher profits in the last quarter. And SentinelOne (S 6.62%) is another promising option that has yet to join the market's rally. The stock is down 81% from its high, but the company continues to report high revenue growth in the cybersecurity market.
Here's why Unity Software and SentinelOne could be trading at higher share prices in the next year or so as they benefit from the larger rally in tech stocks.
NYSE: U
Key Data Points
1. Unity Software
Unity Software is a leading platform for 3D software development. Video game designers, graphics artists, filmmakers, and industrial users rely on Unity's platform. It also offers solutions that help game companies monetize their games. Between 2018 and 2021, Unity's revenue grew nearly three-fold. But slowing growth last year sent the stock down to bargain territory.
While the company's adjusted revenue fell 2% year over year in the first quarter, Unity's growth is far from over. It reported $1.57 billion in trailing-12-month revenue through the first quarter. And while the market for 3D software was estimated at $29 billion just a few years ago, it's only going to grow larger.
One catalyst for Unity over the next year is going to be improving profitability from its acquisition of ironSource, a leader in helping mobile app developers grow their businesses. The two companies are early in realizing the expected bottom-line benefits as they integrate.
Unity reported $32 million in adjusted EBITDA last quarter, up from a loss of $23 million a year ago. As Unity continues to integrate ironSource, management is targeting $1 billion in adjusted EBITDA by the end of 2024. The improvement already reported in the first quarter shows the company is turning the corner on this objective.
The stock trades at an enterprise value-to-EBITDA multiple of 18. The average EV/EBITDA multiple of software application companies is 20 or higher, so even after the run-up this year the stock still has upside opportuntity.
NYSE: S
Key Data Points
2. SentinelOne
Top cybersecurity provider SentinelOne is another discounted growth stock worth buying. SentinelOne continued to report robust revenue growth over the past year, but Wall Street punished the stock over losses on the bottom line in favor of competitors like CrowdStrike Holdings which are reporting positive free cash flow. But with Sentinel's margins starting to improve, the stock looks oversold.
Sentinel's revenue grew 70% year over year in the first quarter, and while that is slowing from year-ago numbers, it's still higher than the numbers of its competitors. These robust growth rates indicate the necessity of cybersecurity in 2023.
SentinelOne now serves half of the Fortune 10. Its customer count grew 43% year over year last quarter, so the higher level of revenue growth indicates that the company is seeing existing customers adopt additional services, which is a great sign.
It's become a standard strategy for small tech companies to prioritize winning customers first and worry about profits later. But SentinelOne is starting to address its lack of profitability by tightening up spending. Adjusted operating margin was negative 38%, a big improvement over last year's negative 73%. It's another great sign to see free cash flow turn higher in the recent quarter, and further improvement should serve as a strong catalyst for a rally in the stock over the next year.
Better news on margins in the coming quarters will likely see Wall Street revalue the company at a higher price-to-sales (P/S) ratio. SentinelOne's P/S ratio of 8.8 looks low for its record of high growth. Other cybersecurity stocks are trading at multiples well over 10, but the company's improving profitability could change that heading into 2024.
