Just to look at the stock chart for Shopify (NYSE:SHOP), an investor might think good news was everywhere. Shopify stock does trade modestly below an all-time high, reached earlier this month. But SHOP stock has gained over 70% from December lows and now trades at nosebleed valuations.
Indeed, using analyst consensus for 2019, and even backing out the company’s roughly $2 billion in cash and investments, SHOP trades at over 200x 2020 EPS estimates. Forward EV/revenue is in the 10x range. Even considering the whopping valuations being paid for platform stocks, SHOP looks significantly overvalued.
I’m not alone in seeing Shopify stock that way. Fellow contributor Dana Blankenhorn called SHOP a bubble last month. A week earlier, Tezcan Gecgil argued investors should take profits. And back in February, I thought SHOP stock was overvalued – at $190 against a current $206.
A few weeks later, I’m even more convinced. The issue for SHOP stock isn’t just valuation, it’s that the news so far in 2019 really hasn’t been that good. With SHOP stock up 49% already, at some point investors will start questioning just how much they’re willing to pay for Shopify stock.
Bad News for Shopify Stock
To be sure, there is a bull case for Shopify stock. Indeed, I’ve recommended the stock in the past. Growth continues to be impressive. The company has established dominance in the ecommerce platform space, making itself indispensable to thousands of small businesses. And there is room to acquire larger clients, too, further expanding the company’s addressable market.
But even bulls at this point have to admit that something close to perfection is priced in. Analysts who have long been bullish on stocks like SHOP only have an average price target of $187, nearly 10% downside from current levels. Yet perfection isn’t what Shopify has offered of late.
For instance, the initial reaction to fourth quarter results in February was negative. Shopify stock sold off, largely because guidance was modestly disappointing. Investors changed their tune rather quickly but it’s not as if the 2019 outlook was all that impressive, or suggested faster growth than the market expected.
Since then, competition has reared its head. Square (NYSE:SQ) is integrating Weebly, which it acquired last year, making it a more direct competitor to Shopify. More notably, Facebook (NASDAQ:FB) unit Instagram has rolled out Checkout, which allows customers to purchase items directly through the app, potentially bypassing Shopify. Privately held Mailchimp left the Shopify platform this month and acquired a competitor at the same time.
SHOP stock indeed fell on the launch of Checkout and on the Mailchimp news, yet already has recouped the losses. It’s as if investors already assume that Shopify is something close to bulletproof. But that might not be the case.
Other Risks to SHOP Stock
Again, Shopify’s growth is likely to continue. The company has built an impressive platform, and as CEO Tobi Lütke pointed out in the Q4 release, no software-as-a-service company has made it faster to $1 billion in sales than Shopify.
But valuation matters. Competition matters. And risk matters.
SHOP stock has outrun Wall Street. It will take years for the company to grow into even a reasonable earnings multiple, even excluding hefty stock-based compensation, which is guided to total $160 million in 2019 (over $1 per share even after-tax).
And Shopify needs the economy to cooperate. It’s not hard to imagine that current demand might be near a peak. The economy is booming, at least in the U.S. That generally helps small businesses and gives entrepreneurs the confidence to take risks. But as I’ve argued before, small businesses fall first when the economy turns, which could provide a significant blow to Shopify’s growth.
None of these risks are priced in, even with signs that the U.S. economy is starting to slow. It leaves SHOP stock with very little margin for error and at a valuation that seems to leave little room for upside.
As of this writing, Vince Martin has no positions in any securities mentioned.