Shopify (NYSE:SHOP) stock plunged almost 9% on Tuesday after an analyst downgraded the shares. SHOP stock modestly recovered yesterday . However, with SHOP stock having more than doubled in value since the beginning of the year, many observers had called its valuation into question. Now SHOP is in a dangerous position from a chart perspective.
The rise of e-commerce should make Shopify stock a winner in the long-term. However, given its surge in recent months, the analyst downgrade has left SHOP stock in a dangerous position for longs.
Wedbush Downgrades SHOP Stock
Wedbush analyst Vgal Arounian downgraded Shopify stock from “outperform” to “neutral,” primarily on valuation concerns. Arounian said the stock “needed time to digest” the 125% increase in its price. Moreover, he mentioned that he does not expect Shopify’s upcoming Fulfillment Network to be profitable until 2023.
Nonetheless, Arounian raised his price target on SHOP stock to $305 per share, up from his previous target of $270 per share. That exceeds the current price of Shopify stock, which is now trading around $298. However, it comes in below Monday’s closing price of $311.83 per share.
Given the multiples of SHOP stock, Arounian probably made the right call. SHOP’s price–sales ratio of around 27 and its forward price-earnings ratio of almost 300 do suggest that SHOP stock is overvalued.
That said, I can also understand the euphoria surrounding SHOP. Thanks to Shopify, vendors once limited to local markets can now reach the world. Shopify’s platform accomplishes this by enabling small businesses to launch their own e-commerce sites . This allows them to sell online with or without the help of Amazon (NASDAQ:AMZN).
Economy, Competition Could Hurt SHOP Stock
However, I think until the Wedbush downgrade, traders had ignored some serious dangers facing SHOP. For one, Shopify does not have a monopoly in its space. Some e-commerce developers prefer WooCommerce over Shopify. Furthermore, with Adobe (NASDAQ:ADBE) owning Magento, and the likes of Square (NYSE:SQ), Facebook (NASDAQ:FB), and Microsoft (NASDAQ:MSFT) competing in this sector, Shopify could struggle to maintain its market share.
Moreover, the economy is now in the 11th year of its expansion Though economists do not forecast an imminent slowdown, the length of the expansion creates dangers. As of the end of 2018, Shopify served about 820,000 merchants, most of whom are small enterprises, across 175 countries,. Any economic contraction would bring the most pain to the small businesses Shopify typically serves.
That’s not to say Shopify will necessarily suffer during a recession. Analysts predict that overall e-commerce sales will grow from $3.453 trillion this year to $4.878 trillion by 2021. For this reason, traders should not doubt analysts’ average estimates which call for SHOP’s profit to surge 50% this year and 66.7% in 2020.
SHOP Stock Is Risky at These Levels
Despite Tuesday’s tumble, Shopify stock trades above its 50-day moving average. However, a drop below $270.78 per share could turn the Street’s focus to the 200-day MA, which now stands at $208 per share.
If the 50-day MA does not hold, we could see a parabolic move in SHOP. Even if it does not fall below the 50-day MA, traders then have to worry about a double top near the record high of $338.94 per share. While I like Shopify stock’s long-term outlook, it appears the question has become not if holders of SHOP stock will face pain, but how much pain they will face.
Final Thoughts on SHOP Stock
Traders should avoid SHOP in the near-term. The Wedbush downgrade seems to have ended a run during which the stock more than doubled over the last six months. Small businesses continue to add e-commerce platforms such as Shopify. Consequently, Shopify stock should continue to march higher over the longer term.
The problem with buying SHOP stock now is its charts. SHOP could easily fail to hold the 50-day moving average or form a double top Unless Shopify can sustain a new 52-week high, traders who buy the shares will face more potential pain than gain for the foreseeable future.
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.
