Canada’s largest tech stock has had a rough year. Last month, the pain intensified. Shopify (TSX:SHOP)(NYSE:SHOP) dropped 9.8% in September. That extends the stock’s total plunge to 76% over the course of this year.
Here’s why Shopify stock continues to drift lower and what investors should expect next.
Why is Shopify dropping?
There are plenty of reasons for Shopify’s nosedive this year, but I believe they can be summed up in three broad categories: recession, interest rates, and sentiment.
The recession is probably the biggest concern. Economic experts believe Canada’s economy will shrink this year and next as consumers pull back on spending. Families have been squeezed by inflation and lack of wage growth, which is bad news for consumer brands and online shopping. Put simply, Shopify could be facing a lackluster holiday shopping season in winter 2022.
Meanwhile, interest rates have moved much higher. The Bank of Canada has raised the benchmark interest rate to 3.25% and there is a chance the rate could move above 4% in the near term. These rising rates make overvalued technology stocks less attractive. That’s why Shopify stock has plunged further.
Finally, sentiment is driving the stock lower. Investors have faced significant losses this year and are now seeking safety in energy stocks and blue-chip dividend stocks. Volatile growth and tech stocks with uncertain futures, such as Shopify, are simply considered “too risky” in this environment.
Shopify valuation
The bad news is that there could be more pain ahead. There’s no knowing how severe the recession will be or if inflation will rebound higher in the months ahead. These factors could push Shopify stock even lower.
However, the good news is that Shopify is now cheaper on a fundamental basis. The stock trades at an enterprise value-to-sales ratio of 5.6. That’s 90% cheaper than last year when the ratio was hovering closer to 60. It’s also lower than its five-year range of 15 to 60.
What comes next?
Shopify’s fortune hinges on the holiday shopping season. I believe the company’s revenue could be lower than in previous years, while margins might be squeezed by rising costs. Therefore, the stock could certainly move lower.
However, Shopify has roughly $6.95 billion in cash and cash equivalents on its books. That represents 15% of its market value and provides a cushion for the rough patch ahead. The company also has little debt and has recently cut staffing costs to prepare for the downturn.
Meanwhile, the long-term opportunity remains intact. Despite short-term challenges, online shopping penetration is likely to keep growing in the years ahead, giving Shopify enough space to keep expanding.
I believe the next few months could present an opportunity for long-term investors to make a contrarian bet. Shopify’s suppressed valuation makes it attractive despite the challenges that lay ahead.
