From here, the only question about Shopify Inc (NYSE:SHOP) is its valuation. And with the SHOP stock price at an all-time high, that is a tough question. Shopify stock trades at over 13 times 2018 revenue guidance on an enterprise basis, and ~600x 2018 adjusted earnings per share.
But valuation is no reason to short a stock or, in this market, to sell it. It’s why I predicted just last month that the SHOP stock price would hit that all-time high. For growth stocks, it’s the story that sells — and Shopify’s story continues to impress.
Nothing in Shopify’s fourth-quarter earnings last week changes the story here. Results crushed estimates, and 2018 guidance was above consensus as well. Profitability is a long way off — but that’s OK, for now, as the company continues to invest in growth.
At these levels, I can see why even SHOP bulls might get nervous. The stock isn’t cheap, or even close to cheap. But that’s been true for a while now and as long as Shopify keeps growing the way it has, the SHOP stock price will take care of itself.
The SHOP Story Remains Intact
Shopify stock did take a hit back in October when short-seller Citron Research took aim at the company. But I argued then that Citron’s case was far too thin, even if the firm did make a few good points. For all the talk about affiliate marketing and potential FTC violations, Citron’s price target came down to valuation. Herbalife Ltd. (NYSE:HLF), another well-known short target, paid $200 million to settle allegations that went to the core of its business model. That’s a tiny fraction of Shopify’s market capitalization.
Citron argued that Shopify was worth $60 based on peer price-to-sales multiples, using a SaaS cohort that included Workday Inc (NASDAQ:WDAY), Salesforce.com, Inc. (NYSE:CRM) and Square Inc (NYSE:SQ). But that valuation ignored two key facts, both of which were highlighted in the Q4 report.
The first is that shorting based on valuation is a fool’s errand. Citron, which made its bones shorting names like Valeant Pharmaceuticals Intl Inc (NYSE:VRX), should know that better than anyone. A growth stock that continually beats estimates is going to keep climbing — and that’s what Shopify stock has done since.
The second is that Shopify should get at least some premium to those peers, at least based on price-to-revenue. Salesforce.com grew revenue 25% in its most recent quarter. Workday sales increased 34%.
Shopify, meanwhile, increased revenue 71% in Q4 — its most important quarter. That growth gap doesn’t necessarily mean that Shopify stock is more valuable than that of Workday or Salesforce.com. But higher growth generally implies higher multiples.
And it’s not just the numbers — it’s the story. Shopify is expanding its merchant base. It’s at the forefront of a major trend of getting small businesses online — the same type of unique, independent companies that younger shoppers, in particular, love. Once those customers are acquired, they become tremendously sticky, and hugely high-margin. That’s how the SaaS model works; it’s why SaaS stocks like CRM and WDAY have such high valuations. There’s nothing in the Q4 numbers to suggest that SHOP shouldn’t join them.
Is Shopify Stock Overvalued?
To be sure, an argument that the SHOP stock price shouldn’t be $60 doesn’t necessarily mean it should be the current $137 — or $160. And there are valuation concerns.
On this site last week, Lawrence Meyers criticized the company’s lack of profitability and refusal to disclose churn (another factor highlighted by Citron). The churn argument I’m somewhat sympathetic to. Small businesses infamously tend to fail, and if Shopify simply is replacing failing businesses with optimistic, but untried, entrepreneurs, growth eventually will end. As for profitability, however, that should be less of a concern.
The point with a growth stock like Shopify is that it really shouldn’t be profitable. It has an enormous opportunity in front of it. It’s growing its larger “Plus” customer base, even adding Ford Motor Company (NYSE:F), per the Q4 conference call. It’s developing new apps for customers, and even making efforts in augmented reality offerings that can be used by businesses that operate on the Shopify platform.
Those are the types of investments Shopify should be making to drive bigger profits down the line. And one clear takeaway from the call is that the company will be more efficient going forward. Plus customers have dedicated account representatives; that need will fade as the software improves. Operating leverage means margins are going to increase; CFO Russ Jones said it was Shopify’s goal to get operating margins to 20-30% over the next 5-10 years, against expectations for breakeven in 2018.
Is that enough to see the SHOP stock price heading higher? It could be tough. Double 2018 revenue to $2 billion, apply a 25% operating margin and SHOP probably still only generates about $3.50-$4 in EPS, depending on how taxes play out. That’s still a 35-40 multiple on a very aggressive, out-year model.
But CRM trades at 65x earnings. WDAY’s forward P/E is 105. If there’s a big opportunity, and market dominance, a company can grow into its valuation. That’s what Shopify continues to do — and betting against it, at this point, seems very unwise.
As of this writing, Vince Martin has no positions in any securities mentioned.
