Shares of ecommerce solutions provider Shopify (NYSE:SHOP) popped to fresh all-time highs in early August after the company reported second-quarter numbers which checked off all the right boxes. There were so many good reasons to keep loving Shopify stock.
Revenues topped expectations, and gross merchandise value rose more than 50% year-over-year, again. Profits topped expectations, too, on healthy gross and operating margin expansion. The third quarter guide came in above expectations. So did the full-year 2019 guide.
At its peak, SHOP rallied 10% in response to an all-time high $350 price tag. Two years ago, this was less than a $100 stock.
In other words, Shopify stock has surged more than 250% higher over the past two years. It has done so despite bears pounding on the table about the stock’s 25-times forward sales multiple being absolutely ridiculous. Indeed, Shopify stock’s forward sales multiple is nearly 50% above the market’s forward earnings multiple… let that sink in for a moment.
How has SHOP stock done this? Why has it continued to make new all-time highs every week despite featuring one of the richest valuations in the entire market? Because that’s the market we have today. In today’s market persistently low rates are a huge benefit to long-duration assets, so investors are flocking to any and all growth stocks with good stories.
Shopify Stock Is a Long-Term Winner
Shopify has arguably the best story in the market (I called SHOP the most exciting stock on the market back in 2017). Consequently, investors are doubly rushing into SHOP stock. Valuation is an afterthought because – so long as rates remain low – one can justify today’s price tag with a big enough projected growth rate and a low enough discount rate.
What’s the investment implication here? Stick with Shopify stock so long as rates remain low. Buy on big dips. But, as soon as rates start to creep higher, do some profit-taking, and then reassess based on where rates settle.
The story here is second-to-none. The global economy is becoming increasingly decentralized. All across the world, single supplier ecosystems are turning into multi-supplier ecosystems. Now, the many are enabled to do what only the few could do before. Think Uber (NYSE:UBER) and Airbnb.
Shopify is a big part of this mega-trend, which I dub the coordinated economy, in that it decentralizes and democratizes the retail process. Now, through Shopify’s array of selling solutions, anyone can sell anything to anyone else through any channel at any point in time.
In this sense, Shopify is enabling an entire new generation of sellers. This new generation has tremendous momentum. Shopify’s GMV growth rate has been 50% or higher for several quarters. Revenue growth has hovered north of 45%. Merchant growth has been above 30%. Yet, Shopify still only commands about 0.2% of global retail sales, so the runway for future growth is very, very big.
Net-net, secular tailwinds imply that Shopify will benefit from steady share expansion in a huge market over the next several years, which should power continued robust revenue growth. Gross margins are steady above 55%. Opex rates will fall with scale. Thus, over the next five to ten years, Shopify has visibility to tremendous profit growth.
Usually, tremendous profit growth correlates to tremendous share price growth. From this perspective, it’s reasonable to label SHOP stock as a long term winner.
Don’t Get Caught up in the Hype
But investors should be careful not to get caught up too much in the hype of Shopify stock and be able to differentiate hype from fundamentals.
The fundamentals here are clear. Shopify controls just 1.5% of e-retail sales today. They are gaining share at a cadence of 20-30 basis points per year. At that cadence, Shopify could easily control about 5% of the e-retail market by 2030. The company is also expanding its presence in the much more crowded but also bigger physical retail sales world. Shopify’s share in that world today is around 0%. By 2030, it could realistically crawl towards 0.5%.
My modeling suggestions that those two assumptions pave a visible pathway for Shopify to claim around 1.5% of all retail sales by 2030, versus 0.2% share today. That share expansion will drive around 25% compounded annual GMV growth between now and 2030, versus ~50% growth today (so naturally slowing growth over time, but still big growth in the long term).
A 25% GMV growth rate should flow into a 20-25% revenue growth rate (subscription solutions growth is a bit of a drag). At that growth rate, Shopify’s revenues could hit $12.5 billion by 2030, versus just over $1 billion in 2018. Gross margins will likely crawl towards 60%. The opex rate will fall consistently towards 30%.
That combination makes $20 to $25 in EPS seem doable by 2030, which lends itself to a 2019 price target of $290 (based on $25 EPS by 2030, a big growth 30-forward exit multiple, and a normal 10% discount rate).
Those are the fundamentals on SHOP stock. The other $60 in today’s $350 price tag is hype.
Will the hype last? Yes. So long as rates remain low. Here’s the math. Instead of a 10% discount rate, let’s use a 7.5% discount rate, based on a long term average equity risk premium of 5.5% and a 10-Year Treasury yield of 2%. When we do that, the 2019 price target gets bumped up to above $360.
Bottom Line on Shopify Stock
Shopify stock is a long term winner that continues to ignore valuation risks because the present valuation is justified so long as rates remain lower for longer. That is to say, prices for SHOP stock above $350 make sense with the 10-Year Treasury yield below 2%. Given U.S. President Donald Trump’s decision to slap more tariffs on China and the Fed’s recent rate cut, it looks like rates will remain lower for longer, so SHOP stock will remain in rally mode.
But, this party ends when rates move higher. As such, I’m sticking with SHOP stock for now, but I am closely monitoring rates with the intention to trim if rates start moving meaningfully higher.
As of this writing, Luke Lango was long SHOP and UBER.
