Why Unity Software Stock Just Jumped 8%

 Investment bank Morgan Stanley upgraded shares of 3D graphics software company Unity Software (NYSE: U) to overweight this morning, and raised its price target to $22 per share.

Unity stock responded by soaring 8% through 10 a.m. ET Tuesday.

What Morgan Stanley said about Unity stock

Quoted by Street Insider this morning, Morgan Stanley analyst Matthew Cost cited significant price underperformance by Unity stock (down 57% over the last 52 weeks) as potentially "derisking" the stock for new buyers.

"Execution headwinds, management turnover, and a major restructuring led to a significant expectations reset," explained the analyst, with Unity's reduction of fiscal 2024 earnings guidance in its Q2 report being (hopefully) the last shoe to drop. With so much bad news baked into the stock price, Cost argues that Unity stock now has basically nowhere to go but up. For all the company's troubles, argues the analyst, Unity has held onto its 70% market share in 3D graphics software.

Logically, therefore, any good news at all should translate into respectable growth going forward.

Is Unity Software stock a buy?

Valuing Unity Software is no easy task. The company is not profitable -- never has been, in fact -- and analysts polled by S&P Global Market Intelligence see generally accepted accounting principles (GAAP) losses extending out past 2028 (which is as far as estimates reach). The company is profitable on a non-GAAP basis, but I'm not comfortable relying on non-GAAP numbers.

Here is the article.

Perhaps the best way to value the stock, then, is on its free cash flow, which according to S&P data amounted to $230 million over the past 12 months, and is expected to double over the next two years. On a $6.5 billion market capitalization, that works out to a price-to-free-cash-flow ratio of about 28, which doesn't seem expensive to me if profits are growing close to 50% annually over the next couple of years.

Despite the lack of GAAP profits, I'm inclined to agree with Morgan Stanley here: Unity stock has potential.