No one will blame you if the past few weeks have been nerve-wracking. While the market as a whole has been relatively steady, some of the most popular stocks on the Nasdaq Composite have been falling quickly.
Those of us who invest in technology stocks — especially Software-as-a-Service (SaaS) ones — have had a roller-coaster ride. One data point: The ARK Innovation ETF (NYSEMKT:ARKK) — which invests heavily in such stocks — fell 25% in a matter of weeks.
But instead of panicking, I used the opportunity to buy shares of Unity Software (NYSE:U), a company that has all the characteristics of a winning stock. Here’s why I say that.
An antifragile framework
Over the past six years, I have developed my own framework for stock picking. Based on best-selling author Nassim Taleb’s work, I have dubbed it the “Antifragile Framework.” These are companies that, by design, I believe will get stronger because of chaos and the right amount of stress.
Last year, the highest-rated “antifragile” stocks averaged a tripling in share price! What did they all have in common?
- Barbell technique: Devoting most of your resources to a reliable (wide-moat) business while still tinkering with high-risk/high-reward projects.
- Financial fortitude: Having enough cash on hand to not only survive a downturn, but get stronger because of it.
- Skin in the game: When those running a company are emotionally bought-in to its long-term success, it tips the scales in our favor.
As you’ll see, Unity is strong in all three areas.
A quick intro to Unity
But before we get into the nuts and bolts, it’s worth explaining what Unity does. Put simply: Its platform helps engineers bring interactive, 3-D technology to life.
Unsurprisingly, the main application for this technology is in gaming. In fact, at the end of 2020, a whopping 71% of the top 1,000 games in the world were made with Unity. That alone speaks volumes — and helps explain how the company has been growing so quickly.
|Revenue||$381 million||$542 million||$772 million||42%|
|Free cash flow||($119 million)||($95 million)||($20 million)||Loss narrowing 59% per year|
While that growth is impressive, management believes the total addressable market for Unity’s platform inside of gaming will reach $16 billion by 2025. That leaves a long runway for growth.
Clearly, gaming is the “safe and reliable” part of Unity’s business. Here are a few stats to demonstrate the strength of that business.
The first shows the number of customers paying Unity more than $100,000 per year. The second — dollar-based net expansion — measures the amount of revenue that existing customers spend with the company year after year. It filters out the effect of new customers on growth.
|Customers paying $100K+||484||600||793||28%|
|Dollar-based net expansion||124%||133%||138%||N/A|
Crucially, these point to enormous switching costs. If you (and your employees) are familiar with Unity’s platform, and rely on it for monetizing your games, it would take a Herculean effort on the part of Unity’s competition to get customers to leave.
Just as important, however, is the fact that this technology can be applied outside of gaming. This is the “high-risk/high-reward” part of the barbell. It includes things like applications in architecture and engineering, the making of movies and animated shows, and autonomous driving.
In fact, Unity already has over 100 customers outside of gaming that provide at least $100,000 annually in revenue. As the ease and reliability of Unity’s platform gain currency, this could grow rapidly: Management believes the opportunity outside of gaming could be worth $17 billion today — more than gaming alone!
Next, I want to make sure a company can not only survive tough times, but get stronger — financially — from them. How is that possible? Companies can buy back their own shares at depressed prices, acquire distressed start-ups, or simply price the competition under the table — losing the short-term battle but winning the war.
While it’s true that Unity appears to be a huge money loser on paper (net losses of over $280 million last year), that’s mostly due to accounting rules. As shown above, Unity is almost at break-even on a free cash flow basis. And when we look at the balance sheet, things are even more encouraging:
- Cash and investments: $1,773 million
- Long-term debt: $0
The bottom line: If tough times hit, Unity has more than enough financial strength to emerge from a downturn stronger than before.
Skin in the game
Finally, I like looking at the “softer” variables: Who runs a company, how they are incentivized, and what employees think of the company culture. Unity has winning marks across the board: Founder-leaders, heavy insider ownership, and rave culture reviews.
|Founder||Current Role||Insider Ownership||Glassdoor Ratings|
|David Helgason and Joachim Ante||Board Member and CTO, respectively||16.7% of shares||4.5 stars (out of 5)|
Of course, an involved founder or happy employees don’t guarantee a winning investment. Then again, nothing can guarantee a winning investment. These factors, I believe, simply tilt the scales ever so slightly in our favor as shareholders.
Unity is worth a look
While I’ve sounded positively bullish throughout this piece, some caution is warranted. Even after falling nearly 50% from all-time highs, Unity still trades for over 20 times sales. It has also only been public for less than one year.
That’s why it’s always smart to buy in small portions. That’s what I did. Today, Unity accounts for just over 2% of my real-life holdings. If you’re looking for a SaaS company with a huge runway in front of it, I suggest you consider doing the same.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.
View more information: https://www.fool.com/investing/2021/03/09/this-is-the-1-stock-i-bought-as-the-nasdaq-plunged/