In March 1957, the S&P Composite became the S&P 500 as we know it today, an index comprising 500 of the largest US companies, designed to be an indicator of the economy at large. Since its inception, the S&P 500 has generated an annualized return of around 7.4%, a rate that would double your money once every 10 years. It’s not too ugly.

However, if you are prepared to do the research, your portfolio could grow even faster. Of course, every investor has their own process, but I start by looking for companies with a competitive advantage, a significant market opportunity and healthy growth in turnover. These qualities point to a future stock price appreciation – and I think Elastic (NYSE: ESTC) and Unity software (NYSE: U) check all three boxes.

Here’s what you need to know about these growth stocks.

Image source: Getty Images.

1. Elastic

Elastic is a research company. Its platform is designed to log data from any source, then search and analyze that information, helping customers tackle a variety of business-critical processes. Specifically, Elastic offers three software products: Enterprise Search, Observability, and Security.

Enterprise Search is a workplace search engine. It helps customers locate specific items in an ever-growing sea of ​​corporate resources, and also allows developers to embed search bars in mobile apps and websites. For example, Shopify uses this tool to feed its help documentation intended for traders. Observability and security extend the power of research to the IT ecosystem, revealing information related to the health of applications, networks and infrastructure. This helps IT and security teams identify performance issues and eliminate threats.

So where is the competitive advantage? According to DB-Engines, Elastic is the most popular enterprise search product on the market, surpassing the second place Splunk by a wide margin. In fact, Elastic topped 16,000 customers in the last quarter, up 33% from the previous year, and the average customer has spent almost 30% more in the past 12 months.

Building on this momentum, Elastic’s revenue is growing rapidly and its free cash flow has recently moved into positive territory.

Metric

Q1 2021 (TTM)

Q1 2022 (TTM)

Switch

Returned

$ 466.8 million

$ 672.7 million

44%

Free movement of capital

($ 10.7 million)

$ 9.1 million

N / A

Source: Ycharts. TTM = 12 rolling months. Note: Q1 2022 ended July 31, 2021.

Management currently assesses Elastic’s market opportunity at $ 78 billion, a figure that reflects the huge impact of digital transformation.

As businesses distribute more resources across public and private clouds, the ability to find, observe, and secure this infrastructure will become increasingly critical. And Elastic’s best solution should help the company capitalize on this huge opportunity. This is why this title sounds like a long term market beater.

2. Unity software

Unity specializes in content development. Its software enables customers to build, deploy and monetize 2D and 3D applications in real time on more than 20 different platforms, including iOS, Android and all major game consoles. This is a big deal, as developers have traditionally built content creation tools from scratch, an expensive and time-consuming process, and these tools often worked on a per-platform basis, meaning that content had to be recoded for each device.

Unity’s approach – build it once and deploy it everywhere – makes the process more efficient. And this value proposition has helped Unity become a dominant force in the gaming industry: 71% of the top 1,000 mobile games were made with Unity software, and 94 of the top 100 game development studios are customers of. Unity. However, its ability to generate income doesn’t stop with content creation.

Unity also provides tools that help developers monetize their games through digital ads and in-app purchases. In this scenario, the company is making money through a revenue sharing model, which means it benefits as the games on its platform become more successful. This should make its business less cyclical than the typical gaming company.

Financially, Unity is increasing its turnover at a steady rate. And while it has posted negative free cash flow of $ 120 million in the past year, its balance sheet shows $ 1.6 billion in cash and investments, but no long-term debt. In other words, Unity can afford to spend money while growing its business.

Metric

Q2 2020 (TTM)

Q2 2021 (TTM)

Switch

Returned

$ 640.3 million

$ 929.5 million

45%

Source: YCharts. TTM = 12 rolling months.

Looking to the future, Unity has opportunities beyond gaming. In 2019, it launched a simulation platform, a virtual world in which engineers can train AI models for autonomous cars and robots. And in 2021, Unity took it a step further by launching synthetic data sets that make AI training faster and more effective. Management believes this expands its addressable market to manufacturing, retail and security.

Unity rates its market opportunity at $ 29 billion, which leaves plenty of room for future growth. And given its leadership in games, I think the company is well positioned to seize opportunities in other industries. This is why this growth stock could help you beat the market in the long run.

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Trevor Jennevine has no position in the stocks mentioned. The Motley Fool owns stock and recommends Elastic and Unity Software Inc. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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