You probably don’t need me to tell you that Shopify (TSX:SHOP) is an expensive stock. Trading at a $111 billion market cap, it’s one of the most richly valued companies in Canada. In the past, it was even the most valuable Canadian company as measured by the combined value of all its shares!
At today’s prices, SHOP trades at 202 times forward earnings, 13.8 times sales, and 9.7 times book value. That’s a pretty rich valuation, even for a technology stock. For comparison, the NASDAQ-100 – the world’s biggest index of tech stocks – trades at a 32 market P/E ratio.
The fact that Shopify trades at high multiples has led many to call the stock overvalued. Indeed, if growth weren’t part of the picture, it would be overvalued. Fortunately, Shopify has above average growth – even for its high-growth sector – therefore, its high multiples don’t tell the whole story. In this article, I’ll explain why Shopify stock’s rich valuation might make sense, while also highlighting some risks facing investors.
Shopify’s growth is strong
The main reason why Shopify isn’t as expensive as it looks is because it has high growth. If a stock trades at 10 times last year’s earnings, but you know that earnings will double next year, then you should conclude that it really trades at 5 times earnings. Now, investors sometimes get carried away with “forward earnings” – such earnings are just estimates – but Shopify’s growth has been remarkably strong for its entire history. In its most recent quarter, SHOP delivered:
- $1.5 billion in revenue, up 25%.
- $49.6 billion in gross merchandise volume, up 15%.
- $1.1 billion in merchant solutions revenue, up 31%.
- $717 million in gross profit, up 12%.
- $86 million in free cash flow, compared with negative free cash flow in the same quarter a year before.
- $0.05 in diluted EPS, up from a loss.
Overall, it was pretty impressive growth. The growth rates were down from the 86% observed in 2020 (i.e., the revenue growth decelerated), but the growth was still such that the company was catching up with its stock price at a rapid pace. Potentially, it will not look so expensive at some point in the future.
The company is arguably back to being profitable
If you looked at the earnings just reviewed, you may have caught something:
Shopify is arguably back to being profitable.
In the most recent quarter, it had positive free cash flow and net income. The e-commerce platform was undeniably profitable for the quarter. It was not profitable in the entire trailing 12-month period, but it may claim that distinction after a few more quarterly releases roll in.
The sky is the limit
A final reason why Shopify’s stock price might not be crazy is because the company’s total addressable market is virtually unlimited. E-commerce is an industry that touches every corner of the globe, and Shopify powers some of the world’s most popular e-commerce sites. As long as the company can keep signing up large vendors, the sky is truly the limit. So, maybe the 202 forward P/E ratio isn’t that nutty after all.
