Timing is everything in the stock market. Unfortunately, sometimes that timing isn’t on your side. On Wednesday morning, I called Shopify Inc (US) (NYSE:SHOP) the most exciting stock in the market. Hours later, famed short-seller Citron Research called the company a “get rich quick” scheme and slapped a $60 price target on the shares, about 50% below where SHOP stock was trading at the time).
It goes without saying that Citron’s bearish report held a lot more weight than my bullish article. SHOP stock plunged more than 11% following Citron’s report, and another 4% yesterday, to hover right around the critical $100 level.
But it also pays to remember that Citron’s bearish reports tend to be overly ambitious on the short side. They target hyper-growth, momentum stocks, and slap outrageously low price targets on those stocks. The bearish reports tend to hit these hyper-growth stocks for a few days before the Citron story fades into the background. Investors then begin to pay attention to the fundamentals again.
From this standpoint, here is what I think happens to Shopify stock over the next several months: The bearish Citron report will likely hang over the stock until the company reports third-quarter earnings, which are due at the end of October. Those numbers will likely be very good and look a lot like second-quarter numbers. SHOP stock will bounce up big, and the uptrend will resume.
Citron Report Doesn’t Make Much Sense
The Citron report says a few things about Shopify’s business, none of which are positive. Firstly, Citron calls Shopify a “get rich quick” scheme which illegally leverages a promotional partner network to recruit the majority of its merchant base. Secondly, Citron says that Shopify has been unable to successfully leverage operating expenses. Thirdly, Citron calls out Shopify’s valuation as too rich and thinks that SHOP’s sales multiple should be cut in half.
But does the report hold much weight?
None at all, actually.
To begin with, Shopify is far from a “get rich quick” scheme. The company is an enabler of e-commerce for hundreds of thousands of small- to medium-size businesses around the globe. These businesses would naturally be eaten alive by Amazon.com, Inc. (NASDAQ:AMZN) and other online retail behemoths in today’s rapidly consolidating retail world if they didn’t have Shopify.
Shopify gives entrepreneurs a tool to level the playing field, and in this sense, its product is both necessary and beneficial.
Also, Shopify hasn’t yet benefited from much operating leverage because it’s not at scale and the company is still investing heavily in its business. You need to spend to grow, especially during the hyper-growth era which SHOP is currently in. They are adding a whole bunch of new merchants, each of which has an acquisition cost.
As the merchant base scales and the new merchant add-rate slows, new merchant acquisition costs will be levered significantly.
Finally, Shopify trades at 17x this year’s sales estimates because it’s growing at such a rapid rate. Citron is comparing SHOP to a whole bunch of lower growth peers. Shopify grew revenues by 75% last quarter. Workday Inc (NASDAQ:WDAY) grew revenue by 41% last quarter, while both salesforce.com, inc. (NYSE:CRM) and Square Inc (NYSE:SQ) increased sales by 26% in the a same period. Wix.Com Ltd (NASDAQ:WIX) reported 51% revenue growth last quarter, while ServiceNow Inc (NYSE:NOW) showed a 40% jump.
No one comes close to Shopify’s growth rate. Consequently, no one should come close to SHOP stock’s sales multiple, either.
Bottom Line on SHOP Stock
The Citron report is a misrepresentation of the facts, much like previous reports from the short-seller. Remember when Citron called Wayfair Inc (NYSE:W) extremely overvalued in 2015 and slapped a $10 fair value on the stock? Go check Wayfair’s stock price today. It’s up above $70.
This is also the same short-seller who shorted Facebook Inc (NASDAQ:FB) last year and said it wouldn’t be a $330 billion company in a year. The market cap at yesterday’s close was just shy of $500 billion.
Shopify stock will also go the other way.
This a growth stock that is only addressing a very small portion of its potential market. Revenue growth is big and supported by secular e-commerce growth trends. Operating leverage is coming soon. Earnings will skyrocket. Like Amazon, SHOP stock will grow nicely into its valuation while rewarding shareholders with handsome profits.
Don’t expect an immediate bounce. But do expect the third-quarter earnings report at the end of the month to right the ship.
As of this writing, Luke Lango was long SHOP, FB, AMZN, SQ, and NVDA.