Unity Stock Soared More Than 10% on Q3 Earnings. Is the AI Turnaround Complete Enough to Buy?

Unity Software (NYSE: U) is booking valuation gains on the heels of the company's recent third-quarter report. The stock was up 14.1% as of 2:15 p.m. ET and had been up as much as 17.7% shortly after the market opened.

With today's gains, the stock is now up roughly 101% over the last year of trading. Should investors chase the rally on the heels performance improvements for the business? Or has Unity's valuation become unreasonably stretched amid a very strong bullish run for artificial intelligence (AI) stocks this year?

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Is Unity stock a buy after strong Q3 results?

Following a string of unsuccessful initiatives and monetization moves for the business, Matthew Bromberg took over as Unity's CEO in May 2024. Under Bromberg's leadership, the company has been carrying out a turnaround initiative that has involved jettisoning unproductive business units and focusing on improving performance for its advertising network. Results have been promising thus far, and signs that the business's comeback is proceeding at healthy pace were evident in the Q3 report.

Revenue for the company's grow segment rose to $318 million -- up 11% on a sequential quarterly basis and 6% year over year. Strong performance for the segment was driven by the company's digital-marketing unit and the success of its AI-powered Vector platform. Gains for the grow segment were partially offset by declines for non-ads businesses. Meanwhile, create segment came in at $152 million -- up 3% year over year.

The company's non-GAAP (adjusted) earnings per share on sales of $471 million beat the average Wall Street analyst estimate's call for per-share earnings of $0.17 on sales of $453.06 million. Overall revenue was up 5% compared to last year's quarter.

For the fourth quarter, Unity is guiding for revenue to come in between $480 million and $490 million. Hitting the midpoint of that guidance range would mean delivering annual sales growth of roughly 6% over the $457 million in sales posted in last year's quarter. Unity's Vector platform is driving strong growth for its ad network, and it looks as if this catalyst is poised to continue powering meaningful improvements for overall business performance.

While the stock could see a significant valuation contraction if the broader market takes a bearish turn or turnaround momentum decelerates, I think the company's long-term setup looks strong. Valued at approximately 9.6 times this year's expected sales, Unity stock could look richly valued in the context of sales growth that is still relatively modest. On the other hand, the company's sales growth is likely to accelerate significantly over the next year and beyond.

Additionally, Unity may have untapped opportunities in the AI space that help to deliver strong returns for long-term shareholders. In addition to artificial intelligence continuing to power market share gains for its ads network, the company may be able to turn data licensing for the training of large-language models and other AI systems into a substantial revenue source.

On the heels of a big valuation run-up, Unity is not a low-risk stock -- and it wouldn't be shocking for shares to see a significant valuation pullback at some point over the next year. Even so, I think the stock has the makings of a worthwhile play over the long term for risk-tolerant investors.

Keith Noonan has positions in Unity Software. The Motley Fool has positions in and recommends Unity Software. The Motley Fool has a disclosure policy.