Many investors may not have had Shopify Inc (US) (NYSE:SHOP) on their radar screen until a few weeks ago. Or if they did, it was because they were watching SHOP stock surge, which despite its early-month fall, is still up almost 150% on the year.
So what happened? Some negative Shopify stock news caused it to fall from $120 and hit $90, albeit briefly, within just a few days time, thanks to a certain short-seller. Citron Research’s Andrew Left hit Shopify with a $60 price target, a 50% decline from where it was trading at the time, and that’s before it was caught “red handed” by the FTC. He contends that Shopify “hides under the shroud of a cloud-based e-commerce solution for Small and Medium sized Business (SMB)” and “is the promoter of the hottest new ‘get rich quick’ scheme on the internet.”
Notably, even if shares did fall to $60, SHOP stock would still be up almost 50% on the year.
Is Left right? He was right about the demise of Valeant Pharmaceuticals Intl Inc (NYSE:VRX). He’s called for BlackBerry Ltd (NYSE:BB, NYSE:BBRY) to nearly double and said its transformation is reminiscent of Nvidia Corporation (NASDAQ:NVDA). That actually seems possible. While these calls may give some confidence, Left is not batting 1.000. For one, his short call on Nvidia didn’t pan out and he’s whiffed on Tesla Inc (NASDAQ:TSLA) before as well, calling for a near 50% fall.
Where Does That Leave Shopify?
I can’t say whether Left’s accusations are right or wrong. Plenty have come out in defense of Shopify. Some have said turning its business model into a fraud would be difficult, while others have said they haven’t heard any talk of an inflated user base. One said Left’s move is “all smoke and no fire.
If you’re an investor in SHOP stock, these claims are important. Or least, the ability to figure out whether they’re true or not is important. I’m not a long-term investor in Shopify and won’t be any time soon. That doesn’t have much to do with Left’s thesis though, although it would if I were looking to take a position. Instead, we can blame the valuation.
Shares trade at some 500 times next year’s earnings estimates. Analysts expect Shopify to post a small loss for fiscal 2017 and a slight profit next year. Because it’s trying to grow its market share now and profits later, an earnings-based valuation probably isn’t the right metric to use. But at 20.7 times sales, it’s not much better. Its gross margins of 55% simply doesn’t justify that figure. Consider that Facebook Inc (NASDAQ:FB), which trades at an obnoxious sales multiple of 15 times, but has a reasonable earnings multiple thanks to wide margins, sports gross margins of 86%.
The move to profitability is a great step for Shopify and it is operating cash flow positive. Heck, even free-cash flow is almost positive. These are great developments. I’m even willing to give Shopify the benefit of the doubt that Andrew Left is completely wrong on his thesis. I am not, however, going to value Shopify as a $10.5 billion company after only doing $390 million in sales in fiscal 2016 with hopes of it climbing to ~$900 million in 2018. Excellent growth indeed, but incredible valuation too.
Trading SHOP Stock
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SHOP stock has done well since tagging $90, climbing about 17% since. But that kind of leaves us in “no man’s land.” A long-term investment is off the table (for me) because of valuation. But a trade is off the table now too.
Originally I was looking to buy Shopify stock into a pullback, if it got to where I was looking. I was hoping for SHOP stock to drift down to the $80 to $85 area, a level of previous support in the past. At the time, the 200-day moving average also would have come into play around that level. It was a reasonable area to buy, but unfortunately, never came to fruition.
SHOP stock is at its 50% retracement level, as we can see on the chart. It’s a coin toss on where it goes next, particularly with Shopify earnings due up on October 31. Halloween is spooky enough without a 50-50 speculative position on the books. I’m steering clear and will revisit Shopify stock at a later date.
Bret Kenwell is the manager and author of Future Blue Chips and is on Twitter @BretKenwell. As of this writing, Bret Kenwell did not hold a position in any of the aforementioned securities.
