Recent Weakness in SHOP Stock Is Turning Into an Opportunity

SHOP stock - Recent Weakness in SHOP Stock Is Turning Into an Opportunity

Source: Shopify via Flickr

As it turns out, high-growth tech stocks are lot like the “Most Interesting Man in the World” from the Dos Equis commercials. They don’t bleed often, but when they do, they bleed a lot. High-growth tech stocks have run into a brick wall this earnings season, and many of them are dropping like flies after their earnings reports. Hyper-growth e-commerce enabler Shopify (NYSE:SHOP) is no different. The company delivered a strong double-beat-and-raise second quarter earnings report. Yet, SHOP stock dropped in response.

SHOP stock was already in sell-off mode prior to the print, thanks to bad reports from Facebook (NASDAQ:FB), Netflix (NASDAQ:NFLX), Twitter (NYSE:TWTR) and others. As a result, SHOP stock is now 20% off its recent highs. Worse yet, that 20% plunge has happened in just a few days.

But, as with many of these other high-growth tech stocks running into brick walls, I think recent weakness in SHOP stock is an opportunity. The technicals on SHOP stock point to it being dramatically oversold in the near-term, while the fundamentals suggests significant upside in a multi-year window.

Consequently, I’m a buyer of SHOP stock on this recent downdraft.

Here’s a deeper look.

Shopify’s Quarter Was Good

Despite the negative stock price reaction, Shopify’s second-quarter earnings report was actually quite good.

Revenues came in ahead of expectations. So did earnings. The full-year revenue guide was lifted and the third-quarter earnings guide came in above consensus estimates.

Revenue growth remained robust at 62%. Gross merchandise value (GMV) growth also remained robust at 56%. The company continued to expand its business services in the quarters, with Shopify Pay growing to eight countries and Shopify Shipping being used by more than one-third of all eligible merchants in the U.S. and Canada during the quarter.

On the negative side, revenue growth is slowing and expected to slow into the foreseeable future. What was nearly 70% revenue growth at the beginning of the year is expected to be 40% revenue growth by the end of the year. Meanwhile, gross margins fell back by 100 basis points in the quarter after several consecutive quarters of expansion.

But revenue growth is expected too slow from such a large base. It’s only natural and obeys the law of large numbers. Plus, 40% revenue growth is still robust. Also, gross margin compression of 100 basis points isn’t all that worrisome considering gross margins are already near 60%. Most of the margin expansion in Shopify over the next several years will be driven by opex leverage, and the opex rate was down 100 basis points in the quarter.

Overall, then, Shopify’s quarter was quite good and illustrated continued strength in the company’s underlying growth narrative.

Fundamentals Point to Long-Term Upside

Much like other high-growth tech stocks, SHOP stock isn’t dropping because the numbers are bad. Rather, the stock is dropping because the price tag sprinted ahead of fundamentals.

I’m a big bull on SHOP stock. But even as a big bull, I pegged SHOP stock’s fair value around $130 earlier this year. Thus, when the stock ran up to $175, I wasn’t convinced it was supported by much else outside of pure euphoria.

Eventually, euphoria always dies down, and reality settles in. We are now in the “reality setting in” part of that cycle. Fortunately, reality setting in on SHOP stock is creating an opportunity for fundamental-oriented, long-term investors.

I still believe SHOP stock is worth somewhere around $130 today, with upside to nearly $300 over the next 7 to 10 years. The thinking behind this valuation is that the entire e-commerce pie is growing by a ton globally, and that Shopify’s piece of that pie (currently 1%) will grow substantially over the next several years, as decentralization tailwinds enable a new economy dominated by entrepreneurs and small businesses.

From this perspective, SHOP stock is a long-term winner. The near-term may be choppy as valuation normalizes. But any drops towards $130 should be viewed as golden long-term buying opportunities.

Technicals Point to Near-Term Upside

On the technical side of things, SHOP stock is dropping into deeply oversold territory. Normally when SHOP stock does this, it bounces back strongly.

For example, the Relative Strength Index on SHOP stock is rapidly approaching oversold territory (under 30). This has happened three times over the past year. Each time, SHOP stock proceeded to bottom out and, then, rally in a big way over the next several months.

Also, SHOP stock is closing in on its 200-day moving average ($130). The 200-day has served as a solid line of support for SHOP stock for several years. The stock almost never touches it. But, during sell-offs, it does get pretty close and then sharply reverses course. Thus, further weakness towards the lower $130’s could be followed by a big pop.

Bottom Line on SHOP Stock

Technicals say buy SHOP stock as it closes in on $130. Fundamentals say do the same thing.

In other words, both the technicals and fundamentals imply that recent weakness in SHOP stock is turning into a buying opportunity.

As of this writing, Luke Lango was long SHOP and FB. 

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