Royal Bank Earns More Than Shopify’s Revenue But Is Worth Less: Why?

Shopify is a great company, but is the valuation simply too high?

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Valuations are entering absolutely absurd levels. That is at least according to Prem Watsa, CEO of Fairfax Financial.

In a recent video call with investors, Mr. Watsa highlighted the reality that Shopify (TSX:SHOP)(NYSE:SHOP) is worth more than Royal Bank of Canada (TSX:RY)(NYSE:RY). The kicker: Shopify’s revenue is less than Royal Bank’s earnings.

This valuation discrepancy is not unheard of among many smaller-cap companies. However, the absolute size of Shopify’s market capitalization is astounding; Shopify is now the largest company listed in Canada.

Shopify a great company

Shopify’s valuation is a reflection on the fact that it is indeed a game-changer in the world of e-commerce. The company is truly a world-class gem that investors are right to want to hold as a portfolio staple.

Shopify’s platform has become essential to so many small- and medium-sized enterprises (SMEs). In the age of the coronavirus pandemic, Shopify’s merchant platform was the difference between life or death for many SMEs. This has allowed for continued growth at a time when most companies are scrambling to shore up balance sheets. Shopify’s cash position and ability to innovate and grow through the turbulent times we’re in is key. This makes investors view Shopify as a safety play, rather than just another overvalued technology stock.

Shopify’s business model isn’t the concern; it’s the valuation

That said, even the greatest companies can be overvalued from time to time.

Shopify isn’t alone in this regard. Many of the mega-cap technology companies traded in the U.S. have seen valuations balloon to levels not seen in some time. The dot-com bubble is often cited as the most recent example of when we saw such valuations on the NASDAQ.

Some investors say high valuations are here to stay, particularly if interest rates stay low for a very long time. That being said, over the very long term, valuations tend to revert toward the longer-term mean. Momentum investors could be in for a rude awakening if we do see such a scenario take place.

Bottom line

Valuations matter for all investors. Those looking to put money to work today have to balance the reality that asset prices across the board have increased. Loose monetary policy has resulted in prices of real estate and other assets outside of equities to become inflated. Getting a reasonable return in today’s market isn’t easy. Riding the momentum wave has also worked out well, making the argument for owning Shopify today intriguing.

With all that in mind, investors should remain cautious with respect to all investments. No investment should be made on the basis of historical returns, but rather on the discounted estimated future cash flows of said company. On that basis, fundamental long-term investors may be better suited gravitating toward the Royal Banks of the world right now.

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 Chris MacDonald 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. The Motley Fool recommends FAIRFAX FINANCIAL HOLDINGS LTD.

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