Is Shopify Inc. a Smart Growth Investment?

It has been a very exciting month for investors of Shopify Inc.  (TSX:SH)(NYSE:SHOP) as the shares have risen by 22%. While this is still down over 40% from where it was in the fall of 2015, the stock has rebounded nicely off its all-time lows.

But why is the stock finally rebounding?

To understand that, it helps to understand the business model that Shopify has built.

Rather than being an e-commerce business itself, it has built a suite of products that other businesses looking to sell online might use. Before services like Shopify existed, if a business wanted to sell online, it would require a significant investment in developers, integration of payment APIs, and paying for a design. Businesses were looking at thousands of dollars in investment.

With Shopify, a merchant can get their website up in a few days, and they only have to pay US$9-179 per month. Further, its built-in payment mechanism called Shopify Payments charges a fee slightly greater than what credit card companies demand. This allows Shopify to reap the benefits when its merchants sell things. In other words, if the merchant does well, Shopify does well.

This subscription model plus the fee-based transaction model make Shopify very appealing to me. For the most part, the business is able to predict how much revenue it should bring in each month, which allows it to scale in a responsible way. But what I really like about this business is that it becomes an integral part of a business’s online operations; in other words, once a merchant has a Shopify website up and running, they’re less likely to switch to a different provider.

This low-churn model has allowed the company to focus on finding new customers without needing to do too much to retain the old ones. In its most recent quarterly report Shopify showed that it had 243,000 merchants on the platform. The quarter before that, it only had 200,000 merchants–that’s significant growth. While a decent bulk of that was due to the holidays, these merchants aren’t likely to leave because the holidays are over.

What excites me about this company is that it is moving toward a day when it will be profitable by reducing its operating costs as a percentage of revenue. In 2012, 84% of revenue went to operations. A year later that dropped to 79%. In 2014 that was down to 73%. In the nine months reported in 2015, that was down to 60%.

One of the driving factors of this is the fact that it is costing the company less money to sign up a new merchant. In the past Shopify had to spend close to $1,000 in customer-acquisition costs. Now it only spends about $500. As it is able to decrease its overall costs, the company will approach profitability.

All told, I believe Shopify has a lot of growth ahead of it. Once the company reaches profitability, I expect it will be able to offer outsized gains for its investors. Investing in technology stocks can take time, but the returns have the potential to be incredibly significant.

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Fool contributor Jacob Donnelly has no position in any stocks mentioned.

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