Shopify (TSX:SHOP) Stock: Worth the Risk?

Shopify has proven itself to be a growth monster. The stock has overshot its book value and earnings by a margin that’s rarely seen.

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Few companies have managed to beat market expectations the way Shopify (TSX:SHOP)(NYSE:SHOP) has. People have been saying that the company is overvalued and overbought for years and is due for a major correction. But that has not stopped the company’s stock to rise again — and become even more overvalued.

This is a point in the company’s favour, namely that it attracts investors, despite its dangerously high valuation. But it also makes Shopify an unattractive stock to the more prudent investors. While many investors want to take advantage of Shopify’s monstrous growth, they fear that the stock has finally peaked and that correction might be just around the corner.

To understand whether Shopify is worth the risk, we have to take a look at its strengths and weaknesses.

Shopify’s strength

Shopify is one of the most prominent e-commerce platforms. When it comes to market share, Shopify stands in third place, behind WooCommerce and Squarespace, making it one of the major players in the continually expanding market. The e-commerce market is far from saturation, so Shopify still has a lot of room to grow and increase its consumer base.

The platform is currently used to power over a million businesses around the world. But the way the company is expanding its business, the number is expected to rise rapidly in the future. The pandemic fast-tracked the conversion of retail businesses into e-commerce, and if Shopify can properly leverage that momentum, it can drastically increase its yearly revenue.

Unlike most other platforms, Shopify was made for business owners that don’t have the technical background. It’s super easy to use and straightforward to set up. Also, it’s a hosted platform, which means businesses using Shopify don’t have to modify their code or add features; the platform does that itself and continuously updates. This convenience, coupled with their customer support, breeds consumer loyalty.

Shopify’s balance sheet is solid; it has minimal debt and a huge cash pile.

Stocks weaknesses

The stock is overpriced, even for an exemplary growth stock. It’s currently trading at a price-to-book of 27.1 times, and forward price-to-earnings of 294.2 times. The company has increased its revenue at a rapid pace. Its 2019 revenue was about 670% more than its revenue in 2015, and it’s only going to increase in 2020.

While that’s not a weakness, the problem is the company’s operating income. Despite increasing its revenue at such a high pace, the EBITDA is in the red every year. It can be partially attributed to the amount of money the company spends on research.

Foolish takeaway

While the company’s strengths, including its financial standing (even if you consider the operating income), far outweigh its weaknesses, this only proves that it’s a great business. But it doesn’t justify Shopify’s overvaluation. Consumer sentiment around the company, especially during the pandemic, has made the company too expensive. But that’s not the only reason to not buy Shopify.

Even if the company grows its price to $2,000 per share, that would only be about 44% capital appreciation from its current valuation. And the chances of the stock normalizing and falling below its current value are higher than the stock touching $2,000. So I would say it might not be worth the risk.

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 Adam Othman owns shares of Shopify. Tom Gardner owns shares of Shopify. The Motley Fool owns shares of and recommends Shopify and Shopify.

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