Unity has been on fire lately. In the past six months alone, the company’s stock price has rocketed 110%, reaching $42.03 per share. This was partly due to its solid quarterly results, and the performance may have investors wondering how to approach the situation.
Is there a buying opportunity in Unity, or does it present a risk to your portfolio? See what our analysts have to say in our full research report, it’s free.
Why Is Unity Not Exciting?
We’re glad investors have benefited from the price increase, but we’re passing on Unity for now. Here are three reasons we avoid U, plus one stock we’d rather own.
1. Long-Term Revenue Growth Disappoints
A company’s long-term sales performance can indicate its overall quality. Any business can put up a good quarter or two, but many enduring ones grow for years. Over the last five years, Unity grew its sales at a 16.9% annual rate. Although this growth is acceptable on an absolute basis, it fell slightly short of our standards for the software sector, which enjoys a number of secular tailwinds.
2. Weak Billings Point to Soft Demand
Billings is a non-GAAP metric that is often called “cash revenue” because it shows how much money the company has collected from customers in a certain period. This is different from revenue, which must be recognized in pieces over the length of a contract.
Unity’s billings came in at $557.8 million in Q2, and over the last four quarters, its year-on-year growth averaged 12.3%. This performance was underwhelming and suggests that increasing competition is causing challenges in acquiring/retaining customers. 
3. Shrinking Operating Margin
Many software businesses adjust their profits for stock-based compensation (SBC), but we prioritize GAAP operating margin because SBC is a real expense used to attract and retain engineering and sales talent. This metric shows how much revenue remains after accounting for all core expenses — everything from the cost of goods sold to sales and R&D.
Looking at the trend in its profitability, Unity’s operating margin decreased by 2.4 percentage points over the last two years. This raises questions about the company’s expense base because its revenue growth should have given it leverage on its fixed costs, resulting in better economies of scale and profitability. Unity’s performance was poor no matter how you look at it - it shows that costs were rising and it couldn’t pass them onto its customers. Its operating margin for the trailing 12 months was negative 30.4%.
Final Judgment
Unity isn’t a terrible business, but it isn’t one of our picks. After the recent rally, the stock trades at 7.7× forward price-to-sales (or $42.03 per share). Beauty is in the eye of the beholder, but our analysis shows the upside isn’t great compared to the potential downside. We’re fairly confident there are better stocks to buy right now. Let us point you toward an all-weather company that owns household favorite Taco Bell.
Stocks We Would Buy Instead of Unity
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