Is Shopify (TSX:SHOP) Stock Due for a Bigger Plunge?

Shopify Inc. (TSX:SHOP)(NYSE:SHOP) stock looks to be running out of steam, but should long-term investors prep for a big plunge?

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Shopify (TSX:SHOP)(NYSE:SHOP) is an incredible Canadian growth story over the years, as shares have doubled up many times over. There’s no doubt about that. Even growth-savvy American investors have put the Canadian e-commerce kingpin at the top of their radars. While it’s likely that the firm, led by the visionary founder Tobias Lütke, remains in the early innings of its long-term growth story, investors must always consider the price they’ll pay for what they’ll get.

You see, all investing, including growth investing, is value investing, as Warren Buffett once stated.

Sure, hyper top-line growth rates, a dominant position in a lucrative market, an exceptional management team, and impeccable profitability prospects warrant a higher valuation multiple.

However, you must resist the urge to play the game of greater fools (that’s a real concept, and it has nothing to do with the Motley Fool!) and run the risk paying up for too many years’ worth of high expectations right off the bat. Because valuation always matters, even with a name like Shopify, where some believe that any price is worth paying given the calibre of the business.

How does one even value a white-hot stock like Shopify that’s continued to defy the laws of gravity?

Shopify stock: A worthy growth investment? Or a ticket to play the game of greater fools?

At around $1,000, Shopify stock, which has always traded at a pie-in-the-sky multiple (such as 20-30 times sales) that no value-conscious investor in their right mind would consider “cheap” based on traditional valuation metrics, has become ridiculously expensive of late, even by Shopify’s standards.

Amid the coronavirus crisis, Shopify got a significant jolt as small- and medium-sized businesses (SMBs) scrambled to get every edge they could. In prior pieces, I noted that SMB merchants saw Shopify and its value-adding services as a “crucial lifeline” amid the unprecedented crisis that threatened their survival. I also pounded the table on Shopify stock, as it unjustifiably plunged on the February-March coronavirus crash.

Profound tailwinds

Shopify continues to fire on all cylinders while riding newfound tailwinds. The company is also demonstrating tremendous resilience through these times of economic hardship. Heck, you could say the stock is recession resilient.

While there’s undoubtedly a lot to love about the Shopify growth story today, it’s important to remember that even the most wonderful business in the world can have a lousy stock if it’s overpriced. And with Shopify stock trading at just shy of 50 times sales (that’s sales, not earnings), I’d say shares of Shopify may be overdue for one of its inevitable pullbacks, after more than doubling off those March 13th lows.

At around 50 times sales, Shopify stock is stupidly expensive, not just by hyper-growth stocks standards, but by Shopify’s standards. Shopify stock has averaged a 19.1 times sales multiple over the last five years. Although the multiple has propped up of late because of promising tailwinds, I think investors need to draw the line and expect some sort of reversion towards mean historical valuation metrics.

Are Shopify’s newfound tailwinds worth the magnitude of multiple expansion it’s enjoyed lately?

That’s the million-dollar question, but if you consider yourself a risk-averse investor, now may be a time to take profits on the name and play with the house’s money, as the risk of a substantial correction, I believe, now looks quite high.

If you’ve yet to get skin in the game yet, it can’t hurt to wait until a meaningful pullback, so you don’t run the risk of overpaying for a stock that sports a price-to-book and price-to-sales multiple that’s more than double its historical averages.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Joey Frenette has no position in any of the stocks mentioned. Tom Gardner owns shares of Shopify. The Motley Fool owns shares of and recommends Shopify and Shopify.

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