The shares of gaming-engine company Unity Software Inc. (U) hit their $207 all-time high on November 15, 2021, after the company's third-quarter revenue and EPS surpassed Wall Street estimates, and the company increased its guidance for full-year 2021 revenue to $1.08 billion - $1.09 billion, up 40% year-over-year.

The company agreed to acquire Weta Digital for $1.63 billion, which should help it develop VFX tools and focus on metaverse opportunities. The stock has gained 39.5% in price over the past month and 124.8% over the past six months to close yesterday’s trading session at $196.65. 

However, Cathie Wood's ARK Invest has sold $27 million worth of U shares. In addition, the company recently witnessed a decline in hedge fund sentiment. Furthermore, its non-GAAP loss from operations is expected to be between $20 million - $25 million for the fourth quarter. And since the company is not expected to turn profitable anytime soon, its near-term prospects look bleak.

Click here to check out our Software Industry Report for 2021

Here is what could influence U’s performance in the upcoming months:

Top Line Growth Doesn’t Translate into Bottom Line Improvement

For the fiscal third quarter, ended September 30, 2021, U’s revenue surged 43% year-over-year to $286.33 million. The company’s non-GAAP gross profit increased 45.7% year-over-year to $231.57 million.

However, its non-GAAP loss from operations for the quarter decreased 44% year-over-year to $12.08 million. In comparison, its non-GAAP net loss came in at $14.81 million, compared to $14.28 million in income in the prior-year period. Its non-GAAP loss per share was $0.06, versus $0.09 in the year-ago period.

Stretched Valuation

In terms of forward EV/S, U’s 50.49x is 1,072.6% higher than the 4.31x industry average. Likewise, its 51.79x forward P/S is 1,107.6% higher than the 4.29x industry average. And the stock’s 32.99x forward P/B is 402.8% higher than the 6.56x industry average.

Low Profitability

In terms of trailing-12-month asset turnover ratio, U’s 0.38% is 40.1% lower than the 0.64% industry average. Its 9.84% trailing-12-month levered FCF margin is 17.8% lower than the 11.97% industry average. And the stock’s trailing-12-month ROCE, ROTC, and ROTA are negative compared to the 8.16%, 4.93%, and 3.64% respective industry averages.

Unfavorable Analyst Estimates

Analysts expect U’s EPS to remain negative in the current quarter, next quarter, current year, and next year. In addition, Wall Street analysts expect the stock to hit $168.63 in the near term, which indicates a potential 14% decline.

POWR Ratings Reflect Bleak Prospects

U has an overall rating of D, which equates to Sell in our POWR Ratings system. The POWR Ratings are calculated by accounting for 118 distinct factors, with each factor weighted to an optimal degree.

Our proprietary rating system also evaluates each stock based on eight distinct categories. U has a C grade for Quality, which is in sync with its lower-than-industry profitability ratios.

U also has a C grade for Growth and a D grade for Sentiment. This is justified because analysts expect its EPS to decline in the near term.

The stock has a D grade for Stability, which is consistent with its 1.35 beta. In addition, U has an F grade for Value, which is in sync with its higher-than-industry valuation ratios.

U is ranked #19 of 23 stocks in the Entertainment - Toys & Video Games industry. Click here to access U’s ratings for Momentum also.

Click here to check out our Video Game Industry Report for 2021

Bottom Line

U’s shares have rallied over the past few months but seems to have reached their peak. Also, given that the company could not generate a profit in the last 12months, the stock looks overvalued at its  current price level. So, we think it is best avoided now.

How Does Unity (U) Stack Up Against its Peers?

While U has an overall POWR Rating of D, one might want to consider investing in the following Entertainment - Toys & Video Games stocks with a B (Buy) rating: SEGA SAMMY HOLDINGS INC. (SGAMY), Electronic Arts Inc. (EA), and DoubleDown Interactive Co., Ltd. (DDI).

Note that EA is one of the few stocks handpicked currently in the Reitmeister Total Return portfolio. Learn more here.

U shares were trading at $193.68 per share on Wednesday afternoon, down $2.33 (-1.19%). Year-to-date, U has gained 26.20%, versus a 26.48% rise in the benchmark S&P 500 index during the same period.

Nimesh Jaiswal's fervent interest in analyzing and interpreting financial data led him to a career as a financial analyst and journalist. The importance of financial statements in driving a stock’s price is the key approach that he follows while advising investors in his articles.

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