Where Did Shopify Stock Go Wrong?

Shopify (TSX:SHOP) stock may remain on investor radars, but not necessarily in their portfolios. So, what happened?

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It seems as though Shopify (TSX:SHOP) stock could do no wrong just a few years ago. Even in the last year, Shopify stock was able to search up words as it showed an improvement in earnings. So, what happened? 

Shares of Shopify stock are now down 34% from their 52-week high. So, what went wrong? Today, we are going to uncover some answers.

All-time highs

Part of the problem for Shopify stock is actually to do with its successful past. During the COVID-19 pandemic, Shopify experienced unprecedented growth as businesses worldwide rushed to establish or expand their online presence. Lockdowns and social-distancing measures forced consumers to shift to online shopping, creating a surge in demand for e-commerce solutions. Shopify, being one of the leading e-commerce platforms, benefited immensely from this shift. The company’s revenue and user base grew rapidly, leading to a significant increase in its stock price.

However, this explosive growth was not sustainable. Much of the future growth was effectively “pulled forward” during the pandemic. As the world began to normalize, with physical stores reopening and consumer behaviour balancing between online and offline shopping, Shopify stock’s growth rates started to decelerate. Investors, who had priced in continued high growth rates, began to reassess the stock’s valuation, leading to a decline in its price.

The broader economic environment has also played a crucial role in Shopify’s stock performance. One of the significant factors has been the rising interest rates. Central banks worldwide have been increasing interest rates to combat inflation. Higher interest rates make borrowing more expensive for companies. This can slow down their expansion plans and reduce their profit margins. As interest rates rise, fixed-income investments like bonds become more attractive to investors. This shift in investor preference can lead to a selloff in growth stocks, which are generally seen as higher risk.

Valuation concerns

Shopify’s stock has historically traded at high valuation multiples, reflecting the market’s expectations of continued high growth. Even after the recent decline, Shopify trades at about 12 times its price-to-sales ratio, which is still considered high compared to other high-growth tech stocks. This premium valuation means that any slowdown in growth or unfavourable economic conditions can have a significant impact on the stock price.

Now, Shopify stock’s recent shift from fixed contract rates to variable platform fees has introduced some uncertainty. While many premium merchants have locked in favourable three-year contract rates, this change could impact future revenue stability and predictability. This shift necessitates continuous investment in customer acquisition to maintain the merchant base, which can be costly and impact profitability.

Improvements needed

There are now several areas where analysts want to see improvements. While Shopify has experienced substantial revenue growth, analysts are keen to see this continue at a strong pace. Sustaining double-digit revenue growth over the next few years is crucial. This is particularly important as the company transitions from its pandemic-induced growth spurt to more normalized growth rates.

Furthermore, gross merchandise volume (GMV) is a critical indicator of the overall sales facilitated through Shopify’s platform. Analysts are looking for continued increases in GMV, driven by both the addition of new merchants and higher sales volumes from existing merchants. This metric is vital as it directly impacts Shopify’s transaction-based revenue streams.

Shopify’s profitability metrics, including gross profit margin and net profit margin, are areas of significant interest. Analysts want to see improvements in these margins, reflecting better cost management and operational efficiency. Achieving higher profitability can provide a stronger foundation for sustainable long-term growth.

Then, there is good, old earnings per share (EPS). EPS growth is a key indicator of the company’s profitability on a per-share basis. Analysts are closely monitoring this metric, expecting continued increases. A strong EPS growth trend can boost investor confidence and support higher stock valuations.

Bottom line

Overall, while Shopify’s growth potential remains promising, analysts emphasize the importance of these metrics in assessing the company’s long-term viability and investment attractiveness. Improving these areas can help mitigate concerns about its current high valuation and support continued investor confidence. So, be sure to keep an eye out, as these could indicate another surge in shares.

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 Amy Legate-Wolfe has positions in Shopify. The Motley Fool has positions in and recommends Shopify. The Motley Fool has a disclosure policy.

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