Long-Term Investors Should Consider Buying SHOP Stock Near $250

September has been a tough month for Shopify (NYSE:SHOP) stock, one of Canada’s most coveted tech names. On Aug. 27, SHOP stock reached an all-time high of $409.61. Despite the recent drop in price, year-to-date, Shopify stock is still up an eye-popping 135%.

Shopify Stock Doesn't Have a Reasonable Price, and It May Not Matter

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Although SHOP stock’s revenue growth continues to impress Wall Street, there might be further volatility and profit-taking in the shares. However, long-term investors are likely to find value in the stock as the price declines more.

Let’s look at what may be next for Shopify stock in the final quarter of the year.

How SHOP Stock Makes Money

In a nutshell, Shopify sells out-of-the-box e-commerce solutions. The company’s growth comes from two main segments: Merchant Solutions and Subscription Solutions. Many on Wall Street credit the company’s success with a wide range of tools that enable store owners to easily manage their businesses.

On Aug. 1, SHOP stock reported strong Q2 results that beat analysts’ average estimates, thanks to strong demand for its subscription solutions. On an adjusted basis, the group earned 14 cents per share.

Shopify stock’s revenue of $362 million surpassed the $350 million expected by analysts. It was a 48% increase from the comparable quarter in 2018.

Merchant Solutions revenue grew 56%, to $208.9 million. Merchant Solutions includes tools that enable sellers to serve their customers better and sell more products. Within Merchant Solutions, SHOP offers payment services, shipping services, and a working capital management tool.

Subscription Solutions revenue grew 38% to $153 million. Subscription Solutions offer merchants of all sizes monthly recurring subscription plans that cost from under $10 to over $2,000 per month.

Shopify Plus, the premium version of Shopify, has over 5,300 customers, including names like Johnson & Johnson (NYSE:JNJ), Unilever (NYSE:UL), and the Obama Foundation.

A quarter of the company’s monthly recurring revenues comes from Shopify Plus merchants. SHOP recently launched a multi-currency feature for Shopify Plus merchants who also use Shopify Payments.

CEO Tobi Lutke recently stressed that SHOP would continue to innovate and launch new products and services for both merchants and their customers. Wall Street also expects the company to continue to grow via acquisitions.

As of June 30, 2019, Shopify had an impressive $2.01 billion in cash, cash equivalents and marketable securities. A year ago, that number stood at $1.97 billion.

Shopify Stock Is Growing Internationally

Management has also been looking at expanding overseas, especially in non-English-speaking countries, as the company’s next key growth area. In Q2, the company’s overseas customer base grew, enabling its international revenue growth to accelerate.

The leading multi-channel commerce platform has recently announced that Shopify would be extending its cannabis e-commerce platform features to allow U.S. merchants to sell hemp and and hemp-derived cannabidiol where allowed by law. Several of Canada’s provinces have already used Shopify to start online cannabis stores.

Earlier in the year, Shopify launched its payment gateway, Shopify Payments, in Germany, making bank account transfers possible there. In its efforts to expand beyond core English-speaking countries, the company has recently made the Shopify website available in eighteen other languages, including Traditional Chinese, Simplified Chinese, French, German, Japanese, Italian, Brazilian Portuguese, and Spanish.

In other words, Shopify is an attractive company with excellent growth prospects in cloud-based e-commerce, both in North America and globally. However, investors also need to be aware of some question marks facing SHOP stock.

SHOP Stock Has High Valuation

Could valuation worries be behind the recent decline in price in Shopify shares?

SHOP stock bears point out the stock’s high valuation. Different analysts have been warning how the increase in SHOP stock price cannot be justified by various metrics.

Furthermore, in case of an upcoming slowdown in the U.S. or global economy, then the momentum of high-flying names like SHOP stock will slow down, too.

On Aug. 23, CNBC’s Jim Cramer sold SHOP stock, which he was holding in his charitable trust. He is possibly one of the most public commentators to raise the alarm bell on the company.

One of the metrics I pay attention to is SHOP stocks’s price-to-sales (P/S) ratio. Despite the recent price decline, it is still high enough to make value investors run for cover. Shopify stock’s P/S ratio stands at about 27x. To put the metric into perspective, the S&P 500’s average price-sales ratio is 2.1x.

Another way to look at this number is to compare the company’s current  P/S ratio with its P/S ratios over time. Since going public, SHOP stock’s lowest and highest P/S level has respectively been 6.86x and 32.78x. That essentially means that the owners of SHOP stock are paying a lot more for Shopify stock now than they were when the P/S ratio was 6.8x.

Another way to analyze the P/S ratio is to compare it with the ratios of companies in similar sectors. Alibaba’s (NASDAQ:BABA) P/S ratio stands at 8.5x. MercadoLibre (NASDAQ:MELI) stock’s P/S is 14x, and the P/S ratio of Amazon (NASDAQ:AMZN) is 3.6x.

Although the P/S ratio of SHOP stock is very high, investors should also remember that it is only one of many valuation metrics. Moreover, it does not take into account the profitability or costs of Shopify.

What Else Could Derail Shopify Stock?

SHOP bulls are happy to point out that the company’s revenue growth is showing no sign of slowing down. On the other hand, Shopify has not yet reported any profits. In Q2, Shopify stock’s operating loss was $39.6 million, or 11% of revenue.

If SHOP cannot keep meeting the Street’s aggressive growth forecasts, then owners of SHOP stock may become more concerned about its lack of profit, and Shopify stock could drop.

During Q1, SHOP launched its TV and film content division, Shopify Studios, Wall Street is debating why Shopify has decided to create such content. In June, SHOP announced that it would be launching a fulfillment network and offer two-day shipping across 99% of the continental U.S. Analysts believe this ambitious strategy is likely to be quite costly for Shopify. The company expects to invest about $1 billion in the network over the next five years.

Instead of focusing on profits, management wants to expand the company by launching new businesses. Therefore, those who plan to own SHOP stock over the long-term need to pay attention to the cash flows from its new ventures.

Many investors have also been quite concerned about the various reports by short seller Citron Research, which regards Shopify’s business model as a “get-rich-quick-scheme.” Moreover, several analysts have recently downgraded SHOP stock in response to its stellar bull run.

Shopify stock’s price decline in September accelerated when management announced the group would raise about $603 million in a secondary offering, selling 1.9 million Class A shares. Investors are clearly not impressed with this dilution.

Finally, those investors who follow short-term technical charts will be interested to know that Shopify stock has spent a good portion of 2019 in overbought territory. It is possible that some further profit-taking will negatively impact SHOP stock in the near future, possibly prior to its next earnings report, expected in late October.

Bottom Line on Shopify Stock

In a few weeks, SHOP stock is likely to release another strong quarterly report. However,  SHOP stock is simply too expensive for me to hit the “buy” button on it at these levels.

SHOP is a growth stock and a speculative stock. Therefore, in the coming weeks, I expect SHOP to be a battleground between investors and traders. While long-term investors would like to see Shopify stock go back over the $350 level, traders are likely to keep it between $300 and $250.

Markets offer investors plenty of choices to invest their hard-earned cash, and SHOP stock’s fundamentals might not offer the best prospects right now. Therefore, I’d consider buying SHOP stock as the price declines toward $250, or even $200, and not before.

Those who have benefited from SHOP’s 2019 gains may consider taking profits as we look ahead to the next earnings report. Alternatively, they may consider hedging their positions with covered call or put spreads.

When Shopify stock reports Q3 earnings in a few weeks, investors may want to do due diligence to assess whether the number of stores and merchants will continue to grow, whether SHOP stock’s subscription revenue will continue to grow, and whether Shopify will continue to offer merchants a technological lead in the e-commerce platform.

Well-performing stocks tend to keep on winning, and the recent strength of Shopify stock might be a good indication that within three or four years, investors who buy SHOP on weakness are likely to be rewarded handsomely. Shopify could also be acquired by a giant retailer such as Walmart (NYSE:WMT).

As of this writing, Tezcan Gecgil did not hold a position in any of the aforementioned securities.

Article printed from InvestorPlace Media, https://investorplace.com/2019/09/long-term-investors-should-consider-buying-shop-stock-near-250/.

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