Since I wrote about the massive overvaluation of Shopify (NYSE:SHOP) last month nothing has occurred to change my mind. If anything, SHOP stock has gotten worse, especially now that Amazon (NASDAQ:AMZN) has decided to take on Shopify’s potential threat (more on that below).
You need to be more than a little hopeful about Shopify’s prospects if you buy Shopify stock. Its price-to-earnings is so high I can only call it stratospheric. Here is why:
Shopify’s market valuation is now $36.61 billion. But even Shopify is only forecasting $20 to $30 million in “non-GAAP” adjusted earnings (more on that below) for 2019. (GAAP is Generally Accepted Accounting Principles.) At the mid0-point of this forecast, that means Shopify stock trades for 1,464 times ($36,610 million / $25 million) its 2019 earnings.
Let’s just take a shot in the dark and say non-GAAP adjusted earnings next year grow 100% to $50 million. That means Shopify stock still trades for 732 times earnings. That’s too high.
In fact, Shopify’s adjusted non-GAAP earnings would have to increase 100% five times (i.e. $25 million x 100% x 100% x 100% x 100% x 100%) to get to $800 million. At that price Shopify stock’s P/E multiple would still be incredibly high at 45 times earnings.
So you can see SHOP’s “adjusted” P/E multiple is just simply too high at today’s price of roughly $317 per share.
“Adjusted” Earnings and Shopify Stock
As you might suspect, I have a huge problem with the commonly accepted practice of adjusting earnings for fast-growing companies like Shopify. I wrote about a similar situation at Square (NYSE:SQ) last week. Just like Shopify, Square’s turn net income losses into adjusted non-GAAP profits.
For example, the truth is that Shopify is losing money on a GAAP basis. As of June 30, Shopify has lost $52 million so far this year.
But to adjust its earnings into profits, Shopify adds back the stock-based compensation (“SBC”) expenses and associated taxes. So in its Q2 quarterly letter, Shopify forecasts $145 million to $155 million in losses for 2019. But after adding back $175 million in SBC expenses and related payroll taxes, its forecast profits are $20 to $30 million.
As I pointed out in my Square article, this is not realistic. The only honest reason to “add-back” an item is if it is a non-recurring, one-time, and generally non-significant expense.
That is not the case here. The SBC expenses relate to the vesting of employee’s restricted stock grants and options. These expenses are recurring and they are dilutive to earnings. As well, Shopify’s SBC expenses are greater than the net income losses, so they are not insignificant.
I pointed out in my article on Square stock that there is a raging academic debate about the add-backs of SBC expenses. For a summary of the issue, you should read the Financial Times article, “Why You Should Be Wary of Stock-Based Compensation.”
The Financial Times article also quotes Warren Buffett on the subject, who said: “If options aren’t a form of compensation, what are they? If compensation isn’t an expense, what is it? And if expenses shouldn’t go in the calculation of earnings, where in the world should they go?
Amazon and Shopify’s Fulfillment Drive
There is another major reason why Shopify stock is likely overvalued. Analysts do not really yet understand that Amazon will not likely take Shopify’s move into fulfillment lightly.
As I reported last month, Shopify intends to move into competition with Amazon in allowing merchants to store their products at Shopify warehouses. This means the customer would get the product faster than Shopify’s present drop-shipping type order process with merchants and customers.
One thing we know about Amazon is that they can take on any competitor. AMZN spent more than $15 billion in the past 12 months on capital expenditures. It forecast lower revenue and profits going forward, but this will not likely affect its capex spending.
Simply put, Amazon has the financial strength and willingness to make its fulfillment business more attractive with lower prices so as to prevent Shopify from gaining market share. So far very few analysts have factored this in Shopify stock’s valuation and forecasts.
What to Do With Shopify Stock?
Shopify stock is stratospherically overvalued. In reality, a $36 billion valuation for a money-losing company is just too much. So far analysts put up with its earnings adjustments that turn losses into profits.
At some point, usually with a market break or correction, wisdom comes suddenly to holders and analysts of stocks like Shopify. Try not to be one of those people.
As of this writing, Mark Hake, CFA does not hold a position in any of the aforementioned securities. Mark Hake runs the Total Yield Value Guide which you can review here. The Guide focuses on high total yield value stocks, which includes both high dividend and buyback yields. In addition, subscribers a two-week free trial.
