The digital revolution continues to pick up steam. With so much moving online at a such rapid pace, companies like Shopify (TSX: SHOP) have been booming. While the last few years have been extremely volatile for Shopify stock, trends remain extremely positive.
Is it a good time to buy SHOP stock?
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Shopify (SHOP) stock: The roller-coaster ride
Unbridled optimism or doom and gloom: these are two extremes that are very familiar to Shopify stockholders. They’re what has sent the stock to highs of more than $210 and lows of $35 in just three short years.
But what is behind Shopify’s stock price movements? The truth is that behind all of this volatility, Shopify stock is actually very well supported. Its underlying business is benefitting from one of the most powerful and lasting trends today — the digitization of the retail world and the fast-growing number of entrepreneurs.
For example, revenue in Shopify’s most recent quarter increased 28% to $5.6 billion. This is quite impressive on its own but even more so if we consider growth rates of prior years — in 2020, revenue increased 85% and in 2021 it increased 51%. Also, gross merchant volume, which is the value of merchandise sold, increased 40% compared to last year to $60 billion.
Clearly, the ability to connect with the world has given many bright entrepreneurs the tools to succeed. Interestingly, new business applications at Shopify are accelerating, totaling five million per year in 2021 and 2022. This is significantly higher than the prior five-year average. And it represents a shift — more people are succeeding in this online world of business. And it’s driving more people to it.
But Shopify’s stock price has plummeted 71% from its November 2022 highs, leaving investors with two burning questions: what is the fair value of Shopify stock? And is it a good time to buy now?
A business in the making
Despite the strong top-line numbers that Shopify has been able to post, the bottom-line numbers continue to disappoint. In fact, adjusted earnings per share came in at $0.04 in 2022 versus $0.64 in 2021 and $0.40 in 2020. As we wait for consistent profitability from Shopify, we should keep a few things in mind.
Firstly, Shopify is still growing fast. It’s still creating this essential internet infrastructure for commerce. It’s a new business in an emerging industry. This type of endeavour is not easy. And it’s expensive. But it’s worth it, as there’s a big runway of growth ahead of Shopify. This includes a growing global business with Shopify Markets Pro, which is an end-to-end cross border solution that enables merchants to enter +150 markets overnight.
Secondly, this growth requires investment — and lots of it. This is what has been driving the decline in operating income at Shopify. In fact, adjusted operating income was a mere $6.1 million in 2022, or 0.1% of revenue. This compares to adjusted operating income of $718 million in 2021, or 16% of revenue. This hit reflects a new compensation system to attract top talent as well as an increased headcount to support growth.
Revenue growth catching up to Shopify stock’s valuation
Today, SHOP stock is trading at roughly 10 times sales. This is by no means cheap, but it’s a far cry from the days of Shopify’s most outrageous valuations of closer to 100 times sales. This, to me, is encouraging. As revenue growth continues to prove the Shopify story, valuations will continue to come in line. I mean, the last thing I want to do is recommend a stock that’s trading at bubble valuations, no matter the value of the underlying business.
So, at this time, I’m comfortable with Shopify stock’s valuation. I think it’s a reasonable valuation for a growth stock such as this. With a cash balance of $5.1 billion and positive free cash flow of $90 million, Shopify is in a good position to continue to grow and thrive.
