What worries me about the bear case for Shopify (NYSE:SHOP) stock is that it’s too simple. At roughly 22-times 2019 revenue and 350-times 2020 earnings per share, on its face, Shopify stock simply looks overvalued.
The problem is that those types of “easy” bear cases rarely have played out in this market — or for SHOP stock. Indeed, SHOP looked potentially overvalued at the start of the year. And even with a recent pullback, it has gained 150%. The likes of Amazon.com (NASDAQ:AMZN), Netflix (NASDAQ:NFLX), and many others long have been decried as “too expensive.” For long-term investors, they’ve been multi-bagger investments.
Even the broad market has seen sharp valuation-based pullbacks in 2011, early 2016, and late 2018. Those pullbacks have proven to be buying opportunities. A simplistic analysis based solely on near-term valuation metrics isn’t enough due diligence. For most of this decade, in fact, it’s been an easy way to miss out on big gains.
And there is a fundamental argument for SHOP stock, as I wrote in August, even if I didn’t necessarily believe in that argument. Shopify has an enormous opportunity, with the recently announced fulfillment offering a potential driver for growth next decade and, in the meantime, a boost to modeled out-year profits.
But there is a bear case here beyond “350x earnings is too much”. And I expect that bear case to pressure SHOP stock both into, and out of this month’s third-quarter earnings report.
Will the Selloff in SHOP Stock Resume?
The obvious near-term risk is that SHOP stock is fading again. A surprising 25%-plus decline began in late August on very little news. Moreover, it seemed to imply that the SHOP bubble had burst.
But the stock quickly rallied. So did Roku (NASDAQ:ROKU), another of 2019’s top performers, which previously saw a steeper and quicker decline. Clearly, growth stock investors saw value on the pullback: Shopify stock, in fact, recovered almost half of its losses in just a few sessions.
Yet SHOP is reversing again, including a 6.5% loss on Wednesday. This second leg down makes the recent gains seem more like a dead cat bounce than a true bottom below $300.
Meanwhile, fundamentally, there may not be many drivers left. The Street long has been playing catch-up with Shopify stock, but a current $362 price target suggests the recent cycle of upgrades likely has played out. I’d expect Q3 earnings to beat expectations, as Shopify hasn’t missed consensus on either line since going public in 2015. But at $333, strong performance remains priced in. Shopify likely needs an absolutely perfect quarter to jumpstart a rally.
To be sure, calling for a near-term decline in SHOP stock has been a fool’s errand for years now. Betting on that decline has been an easy way to get run over. But it does seem like the incredible, and incredibly consistent run in SHOP that held from December to August has broken. At the least, I’d expect some choppiness from here on out.
Better Plays than Shopify Stock
To be sure, SHOP wasn’t alone in tumbling last month. A number of unprofitable or barely-profitable growth names fell, with Uber Technologies (NYSE:UBER) and Lyft (NASDAQ:LYFT) among the most prominent. There clearly was a correction in the biggest, most expensive names.
For Shopify stock to rally from here, those valuation fears need to recede somewhat. But if they do, it’s hard to see how SHOP is the best pick. At 20x-plus revenue, isn’t Slack Technologies (NYSE:WORK), which has dropped like a stone since its direct offering, a more intriguing play? What about recent initial public offerings like UBER, LYFT, or Chewy (NYSE:CHWY), the latter of which I picked up on the dip?
And if those valuation fears persist, and/or if broad market sentiment weakens, Shopify stock clearly is in big trouble. Yes, growth is impressive. But, again, the stock trades at 22x this year’s revenue.
We saw in last year’s fourth quarter selloff, when SHOP dropped 25%-plus and Square (NYSE:SQ) fell by half, what happens when investors get at all nervous. Given the sensitivity of both companies’ small business customers to a recession, any cyclical worries are going to make their way to the stocks in a hurry. But SQ sits around 37% below last year’s highs. SHOP still trades at more than double last October’s highs.
There are specific characteristics of Shopify stock, beyond the enormous headline multiples, that make it particularly vulnerable at the moment. Other stocks are vulnerable too, but I’d rather look to value plays or fallen growth angels rather than a name that still has risen almost 150% in 2019 alone.
At the least, it’s going to be difficult for SHOP to keep outperforming the market. But given the chart, and still-high expectations heading into earnings, I think it’s going to be difficult for the stock to avoid re-testing last month’s lows below $300.
As of this writing, Vince Martin is long CHWY. He has no positions in any other securities mentioned.