If you’ve overlooked the potential of game developer Unity Software Inc. (NYSE: U), that’s entirely understandable.
The stock has flown under the radar within the sub-industry of software design, as large caps like Synopsys Inc. (NASDAQ: SNPS) and Cadence Design Systems Inc. (NASDAQ: CDNS) post robust double-digit year-to-date rallies.
Unity, meanwhile, is up 10.56% year-to-date but has struggled recently while larger software companies have essentially been trading sideways.
Bank of America upgraded Unity Software stock on September 15, boosting it to “buy” from “neutral,” sending the share price higher. However, as the broader market sold off in the past week, Unity also traded lower, erasing gains from the upgrade.
But that doesn’t mean the upgrade won’t have an impact.
A look at the Unity Software analyst ratings reveals a consensus view of “moderate buy” with a price target of $43.69, an upside of 38.21%. That indicates pretty strong confidence among analysts, who carefully dissect all a company’s metrics and the strength of its sales channels.
In other words, while analyst upgrades aren’t the be-all, end-all when it comes to forecasts, they’re more than hunches based on sunshine and lollipops.
Why Upgrades Matter
An analyst’s upgrade can be a significant indicator of positive sentiment surrounding a stock. It typically means he or she has reviewed the company's financial health, growth prospects, and industry trends. Analysts are usually in touch with company management and frequently visit the headquarters and other facilities, getting a first-hand look at what’s going on.
That’s why it’s a good idea to check MarketBeat’s most upgraded stocks list when doing your research before investing.
One important thing to keep in mind: Wall Street analyst reports are primarily tailored to institutional investors, due to the complexity and the scale of investments these investors handle.
Institutional investors, such as mutual funds and hedge funds routinely move billions of dollars in and out of stocks, taking huge positions. They rely on detailed analysis and forecasts to make their decisions.
While retail investors can definitely find value in analyst estimates, always remember that these reports don’t necessarily align with your individual investment goals and risk tolerance. So when considering these recommendations, also factor in your own unique circumstances.
OK, now that we’ve established that, let’s look at how an analyst upgrade could be a good sign for Unity Software.
Increased Confidence
An upgrade suggests that the analyst has growing confidence in the company's ability to perform well in the future.
Analysts see earnings growing by 79% next year, after the company notches a profit this year, following years of losses, which is typical for a newly public company that’s also a tech stock.
Unity went public in 2018, meaning it’s still in that window where it’s young enough to post some substantial price gains.
Unity Software has a market capitalization of $12.12 billion, putting it on the cusp between mid-cap and large-cap.
An analyst’s positive outlook can attract more investors to a young, small-ish company. That’s what initially happened, as you can see using the Unity Software chart. The stock gapped up 1.71% in heavy volume immediately after the B of A boost, but broader market worries about more Federal Reserve rate hikes pulled Unity back down.
Not to fret. The stock is now on the radar of more institutional investors, which could bode well over the medium to long term.
Market Attention
That increased attention is a factor that could result in a sustained rally.
Unity develops real-time 3D development tools and services for creating and growing interactive, 2D, 3D, augmented and virtual reality environments. Its platform is used by developers, artists and designers to create content for various industries, including gaming, film, retail, automotive, architecture, engineering and construction.
Revenue has been growing at strong double-digit rates, and the company is expected to report a profit for the first time this year.
Earnings and revenue growth are typically engines that drive attention from institutional investors, which, in turn, catches analysts’ eyes. You’ll often see a domino effect from there, as investors spot an opportunity and want to get on board.
This increased interest can drive up demand and, consequently, the stock price.
Long-Term Potential
Investment banking analysts aren’t in the business of evaluating day trades. They take a longer view, usually extending out over the next 12 to 18 months. When you look at Unity’s price target of $43.69, you’re seeing a valuation that Wall Street anticipates based on the potential over that time frame.
According to Bank of America analyst Ryan Gee, the upgrade was partially in response to Unity’s new pricing plans for customers of the company’s mobile game creation software.
Gee also added that "Known risks and execution issues are more than priced into the stock." Gee is saying that challenges he and other investors and analysts are aware of are already considered in the stock’s price.
If analysts’ forecasts for profit growth are accurate, or if the company can beat those, which is what investors typically look for, this stock has the potential to be off to the races in the next 18 months.
