What happened

Shares of Unit software (U 5.21%) fell 74.2% in the first half of 2022, according to data provided by S&P Global Market Intelligence. For its part, the stock market fell by more than 20% during this period, so it is a difficult market. However, investors were particularly bearish about Unity due to its high valuation and a big problem it discovered with its business.

So what

Unity’s software is often used in mobile games. Businesses can build their gaming application and run it through the various solutions provided by Unity. Build solutions are part of Unity’s building segment, while the company’s operating segment records revenue generated from helping to run and monetize applications.

Unity made its initial public offering (IPO) in 2020, which was well received by the market. Investors were excited to own part of a company with a leading position in digital content creation. And with that excitement, Unity shares traded at extremely high valuations.

At its peak in late 2021, Unity had a price-to-sales (P/S) ratio of 55, whereas a cheap P/S ratio is generally considered to be in the single digits. Moreover, his medium The P/S ratio in 2021 was 34, according to YCharts – well above the average stock.

On March 16, the Federal Reserve began raising interest rates. And in May, he voted to raise rates at their fastest pace in 20 years, with continued rate hikes set for the rest of the year.

When interest rates are low, things like bonds offer investors very low returns. As a result, investors pile into stocks and valuations rise. But when rates start to rise, low-risk investments become viable again, causing money to flow out of equities. As a result, valuations fall. And that’s what happened with Unity. Its P/S multiple fell from a high of 55 to where it trades today, at around 10.

In other words, Unity’s P/S valuation is now 80% lower than it was at its peak in 2021, which explains the drop. However, Unity has its own problem that is not related to interest rates.

Unity’s operating segment helps apps deliver effective ads. When the company announced its financial results for the first quarter of 2022 on May 10, it told investors that its algorithm had been fueled by bad data, which will cost it $110 million in lost revenue and take up to two quarters to correct. The stock plunged dramatically as a result.

U Data by YCharts

Now what

Unit stock is an enigma right now. On the one hand, investors should welcome a cheaper valuation because, all things being equal, the chances of positive returns are greatly amplified.

However, all things are not equal. Unity needs to fix its algorithm as soon as possible to restore customer trust and not permanently lose business to competitors.

If you’re buying stock today, you should be confident in Unity’s ability to fix the problem and not let it happen again. For those lacking that confidence, it may be best to take a wait-and-see approach, monitoring results over the next several quarters.

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