2 Things to Know About Shopify Stock

Shopify stock got hit yesterday after reporting strong 2023 results but guidance that was below analyst expectations.

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Despite another very strong year for Shopify (TSX:SHOP), the stock has hit a roadblock. Pricing in the highest of expectations and hopes, Shopify’s stock price is clearly vulnerable, at least in the short term.

Let’s explore the results and guidance and what this all means for the stock.

Shopify stock: Volatility at its best

One thing that we’ve gotten used to from Shopify stock is its volatility. Clearly, investing in this stock is not for the faint of heart. It is for this reason that those of us who do choose to invest in SHOP stock must do our homework and have strong convictions in our decisions. Once this happens, we will be better armed to ignore the strong emotions of fear and greed that come with watching our stock’s volatile movements.

In Shopify’s case, there is certainly a lot that can serve to give us conviction in its bullish outlook. For example, Shopify’s growth trajectory is continuing strong. Its 2023 results saw bullish trends across the board. Revenue increased 26% to $7.6 million. Also, margins are increasing and free cash flow came in at $905 million, for a free cash flow margin of a very strong 21%. This gives Shopify greater resources to continue its growth.

To make a decision on what to do with Shopify stock, let’s keep our eyes on the long term. There are two things in particular that I would draw your attention to. The first is the ramp up of Shopify’s cash flows. Free cash flow, for example, exceeded $900 million in 2023. Also, revenues are still growing rapidly, along with margins. This is positioning Shopify as a force to be reckoned with, both strategically and financially.

Falling expectations

As I’ve noted before, it’s clear to me that Shopify’s stock price has been carrying very high expectations in its valuation. It’s understandable, but it makes the stock more volatile. Trading at more than 100 times earnings is a premium valuation that any growth stock might have trouble living up to.

So, Shopify’s business is clearly extremely successful. However, I think we have to look at the stock through a different lens. The stock has to be a fair representation of the underlying business. As often happens, a stock can become overvalued as investor excitement and optimism skews reality. It’s important to note that analysts’ earnings estimates for Shopify for the next few years have been reduced recently, signalling a recognition that they have been too high.

For SHOP stock to be trading at 100 times this year’s expected earnings and 60 times 2026’s expected earnings, it’s clear that investors are taking their high expectations for the future and more than paying up for it today. While this can work, it seems to be ignoring the possible risks, both anticipated and unanticipated, that might derail or weaken the bullish outlook.

The bottom line

Looking at Shopify stock from the perspective of its risk/reward trade-off, I feel hesitant. Nobody can deny that the business is running well and that the growth potential is huge. The question, however, is how much are we willing to pay for this? And are we prepared to accept the short-term downside risk that comes with investing in Shopify stock?

In conclusion, I think that it’s probably a good idea to take advantage of the volatility and wait for a better entry point.

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 Karen Thomas has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Shopify. The Motley Fool has a disclosure policy.

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