Shopify (NYSE:SHOP) reported reasonably strong third-quarter results on Oct. 29. Unfortunately, investors didn’t like the higher-than-expected adjusted loss of $33.6 million. As a result, SHOP stock fell over the next week.
The good news for the owners of Shopify stock is that most of those losses have been reversed in recent trading. The bad news is that SHOP stock has still lost 15% of its value over the past three months.
InvestorPlace contributor Thomas Niel believes investors should patiently wait for a better entry point in SHOP stock because of Shopify’s nosebleed valuation SHOP has a huge enterprise value-to-sales (EV/Sales) ratio of 24.
But I believe an EV/Sales ratio of 24 will look cheap in three to five years if the company continues to successfully add more merchants to its platform,
Here’s why.
1 Million Merchants and Counting
In conjunction with the Q3 results, Shopify CEO Tobi Lutke announced triumphantly that, as of the end of Q3, over 1 million merchants were on the platform. That target was thought to be unreachable 15 years ago when the company’s first store opened.
“This is kind of blowing my mind right now,” Lutke said.
“I had an investor who ended up not investing because they told me that the worldwide market for online stores was about 40,000 stores,” the CEO added.
I guess that investor feels pretty silly right about now.
One negative mentioned by many in the media is the fact that Shopify’s revenue last quarter grew 45% year-over-year, slower than the 58% top-line growth in Q3 of 2018 and the 72% jump in Q3 of 2017.
What the pundits failed to mention is that it’s natural for business’ growth rates to fall. It’s a lot easier for a business with $200 million in quarterly revenue to grow 72% than it is for a business wit $400 million in revenue.
But the growth of Shopify’s monthly recurring revenue (MRR) did not slow that much. MRR is defined as the number of merchants multiplied by the average monthly subscription fee in effect at the end of the quarter. That metric went from $26.8 million in Q3 of 2017 to $37.9 million in Q3 of 2018 to $50.7 million last quarter.
Shopify’s MRR grew 41.4% from 2017 to 2018. The increase slowed slightly to 33.8%, from 2018 to 2019.
MRR grew $12.8 million from 2018 to 2019, versus an $11.1 million increase between 2017 and 2018.
The Bottom Line on SHOP Stock
As long as MRR continues to grow by double-digit percentage levels, Shopify will be in growth mode. Once that metric starts to fall into the single digits, then we can talk about a maturing business. Until then, I’m not sure the valuation of SHOP stock is excessive.
SHOP stock definitely isn’t cheap, but it’s still worth holding for the long-haul.
Shopify took 19 months to go from 600,000 subscribers to 1 million subscribers. That’s a compound annual growth rate of 37%. If it continues growing at a compound rate of 25%, it will reach 2 million subscribers within a few years.
Not even SHOP’s CEO knows what the ceiling is for the number of merchants on its platform. Someone thought 40,000 was a best-case scenario. Shopify’s current total is at least 25 times that now.
Here comes 2 million.
At the time of this writing Will Ashworth did not hold a position in any of the aforementioned securities.
