Shopify Inc. (NYSE:SHOP) is seeing increased volatility after a four-month downtrend. Investors are wondering if the price has found a grip, or if the stock is still losing ground, especially with today's price action prompting investors to re-evaluate their thesis. In this article, we will re-cap the key fundamentals and estimate if the stock is trading around value.
Shopify provides a platform for merchants to create an online presence and distribute their products. Its main competitor is Amazon (NASDAQ:AMZN), with one of the key distinguishing features being that Shopify caters to merchants while Amazon competes with them and is generally more tilted on the side of the consumer. Shopify aims to capture both big and small merchants, and enable them to reach as many clients as possible.
Shopify has about 1.5 million merchants, and an estimated market opportunity of $20t - Global, ex. China. The company is estimated to help merchants capture 1% of that value, which will bring its gross merchandise value up to 200b. The company's take rate is currently 2.6% which is reflected in the US$4.612b revenues - Shopify is seeking to expand this as it offers more services.
Shopify is estimated to increase revenues to US$10.5b by the end of 2025, which would imply a gross merchandise value of around US$400b, a high growth of about 230%+. Conversely, this would represent some 2% of the total addressable market we mentioned above. While 2% may not seem much, reaching US$10b revenues is no easy feat, and analysts run the risk of assuming high growth will continue long in the future.
There is also a substantial difference between profits and cash flows, with the latter being important for investors. In the last 12 months, Shopify made US$2.9b in net profit, but only US$453.6b in free cash flows. When estimating which number of the two will converge, in theory we assume that profit converges to cash flows, which is also what analysts are projecting in the chart above.
Qualitatively, we must also consider that 2020 and 2021 were unusual years, and consumers did increase their online spending, but also started new businesses - many of which ended up on Shopify. We need to account for the possibility that this enthusiasm for starting new businesses will drop, and part of the started businesses on the platform will fail as people return to the workforce. Hopefully, Shopify can use the boost in earnings to make efficient capital investments that will allow the platform to offset this decline and even drive further growth. None of this is a given, and that is why sometimes we need to wait for results before assigning optimistic valuations.
What is Shopify Worth?
According to our price multiple model, which makes a comparison between the company's price-to-earnings ratio and the industry average, the stock price seems to be justified. In this instance, We’ve used the price-to-earnings (PE) ratio and found that Shopify’s ratio of 33.71x is trading slightly above its industry peers’ ratio of 32.1x.
This means that, if you buy Shopify today, you’d be paying a relatively reasonable price for it. Keep in-mind that a P/E of 33x implies a lot of future growth, which we should watch over to make sure is being delivered. If you believe Shopify should be trading in this range, then there isn’t really any room for the share price grow beyond the levels of other industry peers over the long-term.
We should also consider the profit margin - Shopify's 63% net income margin isn't likely to persist while the company is growing because it needs to invest in order to reach more customers, build barriers to entry and manage competitiveness. Specifically, it needs to further differentiate itself from other e-commerce providers and payment processors that offer partial e-commerce solutions.
Finally, we can put all of this into a valuation model and see, if investors are overpaying on the stock.
Using our broad intrinsic value model, which already assumes high cash flow growth, we arrive at a fair value for Shopify of US$51.7b, or US$410 per share. This would make the stock some 70% overvalued. Our model assumes about US$3.2b of free cash flows in year 10 - If you think Shopify is capable of making more, then you can find the stock to be under or around fair value.
Technology companies like Shopify have a lot of implied growth, and are quite hard to forecast, especially because the technology and landscape changes from year to year - Which is why Shopify is likely a high risk and return stock.
What this means for you:
Are you a shareholder? Currently, SHOP appears to be trading around industry price multiples, but given the uncertainty from negative returns in the future, this could be the right time to reduce the risk in your portfolio. Is your current exposure to the stock optimal for your total portfolio? And is the opportunity cost of holding a negative-outlook stock too high? Before you make a decision on SHOP, take a look at whether its fundamentals have changed.
Are you a potential investor? If you’ve been keeping tabs on SHOP for a while, now may not be the most advantageous time to buy, given it is trading around industry price multiples. This means there’s less benefit from mispricing. In addition to this, the negative growth outlook increases the risk of holding the stock. However, there are other important factors we haven’t considered today, which can help crystallize your views on SHOP should the price fluctuate below the industry PE ratio.
So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. To help with this, we've discovered 3 warning signs (2 can't be ignored!) that you ought to be aware of before buying any shares in Shopify.
If you are no longer interested in Shopify, you can use our free platform to see our list of over 50 other stocks with a high growth potential.
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Simply Wall St analyst Goran Damchevski and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
Goran is an Equity Analyst and Writer at Simply Wall St over 4 years of experience in financial analysis and company research. Personally, Goran has over 4 years of experience in financial analysis and company research, where he previously worked in a seed-stage startup as a capital markets research analyst and product lead and developed a financial data platform for equity investors.