Shopify (NYSE:SHOP) stock is trading lower this week due to a secondary offering, giving investors a rare opportunity to buy a dip in this high-flying eCommerce name. That share sale isn’t alarming. Wall Street knew it was coming and reaction to it has Shopify stock residing about 20% below its 52-week high.
Even with that decline, Shopify stock is nowhere close to being considered cheap or a value play. Here are the jaw-dropping multiples on SHOP stock: 370x forward earnings, 27.48x sales and 17x book value. That’s definitely growth stock territory, but investors waiting for Shopify to offer growth at a reasonable price (GARP) may be waiting awhile and miss out on more upside in the name.
Consider this about Shopify’s growth potential. Today, it’s the third-largest eCommerce company in the U.S., behind only Amazon.com (NASDAQ:AMZN) and eBay (NASDAQ:EBAY). By market value, Shopify is about $5 billion than eBay, but the $38.67 billion market capitalization on Shopfiy stock is nowhere close to the over $900 billion on Amazon.
It would be bold to claim Shopify is the next Amazon, but for investors, it doesn’t need to be.
SHOP stock, which has more than doubled this year, can continue winning by simply stealing smaller percentages of market share from rivals, like Amazon over time, while continuing its best in class merchant retention.
Merchant retention is a big issue in eCommerce and it’s something Amazon could have problems with in the future, given the massive number of complaints found online about selling on Amazon. Much like Uber (NYSE:UBER) drivers don’t think the company cares about them, plenty of Amazon merchants feel the same way. Shopify sellers, many of whom have been with the company since day one, feel differently.
“When we go to the payment companies, when we go to the shipping companies or go to anyone, we negotiate on behalf of more than 800,000 merchants,” said Shopify COO Harvey Finkelstein in a recent interview with Barron’s. “Instead of keeping the economies of scale for ourselves, we distribute [the benefits] to the small businesses. I think that’s why we have been really successful.”
About That Valuation
With Shopify residing in a stratosphere where even epic earnings and sales growth still wouldn’t quash all the criticism of the company’s rich multiples, the company needs to source other avenues for growth.
One area the company is looking to do that, and it puts Shopify into another competitive row with Amazon, is fulfillment. Some analysts see fulfillment as a potentially fruitful endeavor for Shopify stock over the long-term.
“We are taking our out-year revenue expectations up substantially to reflect upcoming fulfillment fee revenue expectation from Shopify Fulfillment Network (SFN),” said Rosenblatt Securities analyst Mark Zgutowicz in a recent note. “SFN capabilities for DTC [direct-to-consumer] transitioning companies (particularly off Amazon) will be immense, in our view.”
Coupled with merchant growth, growth in subscription services such as “Shopify Plus,” fulfillment can be a material role in the outlook for Shopify stock.
“We see subscription revenue growing at a 26% CAGR, with merchant solutions growing at a 33% CAGR over that same period,” said Morningstar in a recent note. “In our view, revenue growth will be driven by new merchants on the platform, uptake of the Shopify Fulfillment Network, Shopify Pay, Shopify Shipping, and Shopify Capital, and growing gross merchandise value on the platform.”
Bottom Line: Margin Improvement Needed
For its most recently reported quarter, the company reported 48% growth, but that’s likely to fall to 30% compound annual growth through 2023. That’s still an impressive figure, but in order for Shopify stock to efficiently handle slower revenue growth, the company must improve operating margins, something analysts expect the company will do.
On a GAAP basis, the company’s margins are currently around -9%, but if it can get to the 2% to 3% area by 2023, that could warrant further premium multiples on SHOP and more upside.
Todd Shriber does not own any of the aforementioned securities.