The recent sell-off in tech stocks has led to divergent views on Shopify (NYSE:SHOP). Some point to its massive growth and high valuations and write it off as overvalued. Others look to the enormous growth of Shopify stock as filling the niche that Amazon (NASDAQ:AMZN) cannot supplant.
With both points of view defining Shopify, observers can easily understand the disagreement. However, rather than taking a side, I think investors should approach SHOP on the assumption that both viewpoints are correct and focus on the present.
Shopify has traded in a range for most of the year. The differing views on the future of SHOP likely explain the ambivalence. Some look at the forward price-to-earnings (PE) ratio that hovers above 220 and conclude that it has nowhere to go but down. Others point to the seemingly low $16.8 billion market cap and believe that it will go up long term.
The Bull Case for Shopify Stock
Interestingly, I agree with both viewpoints. I called Shopify the “anti-Amazon” in previous articles, and I still believe that. Shopify sites enable small businesses to establish online storefronts easily.
Yes, Shopify also faces competition from WooCommerce and other minor players. However, Shopify offers an ease of use not available with WooCommerce. For retailers wanting to spend their time on selling instead of site design and maintenance, Shopify remains a clear choice.
It also offers separation from the likes of Amazon, eBay (NASDAQ:EBAY), and Etsy (NASDAQ:ETSY). This is why Amazon’s attempt to offer a competing platform did not lead to a large selloff in SHOP stock. Shopify’s popularity also explains why I expect Shopify will someday trade at much higher levels than it sees today.
The Bear Case for Shopify Stock
However, that pertains to the future, not the present. As such, the forward PE and its elevated levels create concerns. The current momentum of tech stocks since the fall also bodes poorly.
So far, SHOP has only come down a little bit more than 11% from its 52-week high. Other tech stocks have not fared so well. Amazon fell by almost 20%, and other tech names lost over half of their value. In comparison, the Nasdaq 100 has declined by more than 13%.
Nonetheless, this decline has investors calling high valuations into question. Square (NYSE:SQ), which also supports a triple-digit PE ratio, lost nearly 40% of its value on no news. Square’s impact on small business arguably compares to that of Shopify. Hence, investors should consider the possibility that Shopify stock could follow this pattern.
If bearish sentiments continue, I see little that could stop a further drop. Currently, analysts forecast 93.8% profit growth for this year and a 122.6% increase in 2019. This growth will probably keep the PE ratio of Shopify near or at triple levels for years to come.
Still, that growth does not justify the current earnings multiple by any measure. For that reason, one cannot a rule out the possibility of a much more significant drop in SHOP stock.
While Shopify will remain one of the top ecommerce companies, the stock has moved ahead of itself, and prospective buyers should look elsewhere for now.
The Bottom Line on Shopify Stock
Both bulls and bears will likely be right about Shopify. However, the need to focus on the near-term currently favors the bears.
Small businesses want an ecommerce platform of their own. In this sense, a relatively low market cap, the ease of using Shopify, and the independence offered by the platform favor SHOP stock long-term.
However, valuations also matter. Even the prospect of profits doubling every year does not justify a forward PE ratio exceeding 220. For this reason, investors need to stay away for now.
Although I expect Shopify stock to trade above current levels eventually, prospective buyers have every reason to hold out for a much lower stock price.
As of this writing, Will Healy did not hold a position in any of the aforementioned stocks. You can follow Will on Twitter at @HealyWriting.
