At its heart, the bull/bear battle over Shopify Inc (US) (NYSE:SHOP) stock is an argument over valuation. Over the past six months, that battle mostly has been a stalemate, with SHOP stock up modestly from early August, when it first cleared $100.
The bears have notched a couple of wins. Most notably, SHOP stock tanked after short-seller Citron Research took aim at the stock back in October.
But even the Citron report didn’t argue that Shopify was a scam, or that the business was going to collapse. (Bear in mind that Citron has made those types of accusations in the past, notably in its scathing and prescient report on Valeant Pharmaceuticals Intl Inc (NYSE:VRX).)
Coverage of the Citron report focused on alleged marketing violations – allegations which I wrote at the time had some merit. But the $60 price target Citron assigned to SHOP stock wasn’t based on projected FTC fines or a massive change to the Shopify business model. It was based on valuation.
The problem for SHOP bears is that fighting valuation in a growth stock generally is a losing battle. That’s particularly true in a rising broad market. Shopify’s story is good enough to keep the gains going for some time, as long as the market stays strong. And as such, I expect SHOP stock to head back to all-time highs at $123 this year and beyond.
The Valuation Argument
SHOP stock admittedly isn’t cheap. Even backing out roughly $10 per share in cash, the stock still trades at almost 400x 2018 EPS estimates, and ~11x revenue. In October, using the EV/revenue metric, Citron compared SHOP to other high-flyers like Workday Inc (NASDAQ:WDAY), Salesforce.com, Inc. (NYSE:CRM), and Square Inc (NYSE:SQ) and estimated its value around $60.
But I’m skeptical that comparison is all that useful. EV/revenue isn’t the only metric that matters, even if it’s easiest given the lack of Shopify profits. Longer-term, Shopify (assuming its story plays out ) should trade at a premium in terms of sales multiples, because as it matures it will have a superior margin profile.
And in the near-term, Shopify is growing faster than those rivals. Analysts expect a 44% top-line increase from Shopify in 2018. In contrast, salesforce.com revenue is expected to climb 20% and Workday is projected to post 25% growth.
And, again, valuation isn’t a reason to short, or even sell, a stock. There are plenty of issues in this market that might appear overvalued, with Amazon.com, Inc. (NASDAQ:AMZN) one notable example. But if the business is attractive to investors, and the case for long-term profits remains intact, an “expensive” valuation can hold for years.
That’s what’s happened with AMZN. And it’s likely to happen with SHOP stock, too. Even bears like Citron still see value in the business model. The argument is over price, but that’s generally not an argument bears are going to win.
SHOP Stock Should Rise
Because that business model is hugely attractive. Shopify is targeting small and medium businesses at a time when ‘unique’, ‘independent’ offerings are much-prized, particularly by younger consumers. Switching costs are exceedingly high; once a business moves on to the Shopify platform, it’s unlikely to leave.
Indeed, while Shopify stock chopped through the last few months, fellow small-business player Square saw its stock soar, even with a sharp pullback in late November. That stock now is in similar valuation territory but from a margin and platform standpoint, SHOP looks more attractive.
Valuation aside, Shopify is the type of business investors are going to want to own. Meanwhile, SHOP bears have little in their pocket other than valuation and the FTC maybe shutting down some sketchy affiliate operators, and in the worst case scenario levying a $100-$200 million fine. Bear in mind that Herbalife Ltd. (NYSE:HLF) paid a $200 million fine over marketing violations that were at the core of its business.
All told, the bears have scored a couple of victories of late but their success isn’t going to last. As long as Shopify keeps growing, and broad markets remain reasonably bullish, Shopify stock is going to rise. That in turn suggests that $123 won’t be the stock’s all-time high for too much longer.
As of this writing, Vince Martin has no positions in any securities mentioned.
