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Why Interim Volatility in Shopify Stock Will Persist (… but Don’t Worry)

For most of 2019, shares of e-commerce solutions provider Shopify (NYSE:SHOP) seemed unstoppable. Shopify stock entered 2019 with a $135 price tag. Two strong earnings reports and a ton of hype later, SHOP stock registered an all-time high closing of $410 in late August.

Why Interim Volatility in Shopify Stock Will Persist (… but Don't Worry)
Source: Jirapong Manustrong / Shutterstock.com

In other words, over the span of eight months, SHOP shares rattled off a jaw dropping 200%-plus gain, and did so with minimal volatility (SHOP stock only had one drop of 10% of more during this record rally).

As it turns out, all the volatility was looming in the last few months of 2019. Since registering that late August all-time high, Shopify stock has come crashing down amid a broader shift out  of momentum/growth stocks and a shaky third quarter earnings report which prompted profitability and valuation questions.

At present, SHOP stock trades 20% off its all time highs.

What’s next for this name? Some more turbulence. Zooming out, this is a great company, but Shopify stock simply got ahead of itself. Shares went very far, very fast amid sizable fundamental improvements. As is often the case, though, hype caused SHOP’s valuation to sprint ahead of fundamentals. Over the past few months, the fundamentals have been trying to play catch-up.

They will continue to play catch-up for the foreseeable future because the valuation remains stretched. As such, while Shopify stock looks good long term, it doesn’t look great in the interim.

Shopify Stock Looks Good Long Term

In the big picture, Shopify is a very strong company, and SHOP stock will climb way higher in the long run.

The whole bull thesis on the stock rests on this idea that the retail world is doing two things right now. First, it’s in the early stages of becoming increasingly digital. E-commerce is on the up and up because of its convenience advantages over physical commerce. Given that e-commerce still only comprises ~11% of retail sales in America, the space will continue to grow by leaps and bounds.

Second, the retail world is also in the early stages of becoming increasingly decentralized. For a variety of reasons, Millennial and Generation Z consumers are obsessed with entrepreneurship. That is, they all want to start their own businesses, sell their own products, and work for themselves. The internet enables them to do this. So, the global economy is gradually pivoting toward one powered by start-ups and small-to-medium sized enterprises. This pivot includes the retail world, where we are starting to see a rapid rise in the number of small-to-medium sized merchants and retailers.

Broadly, then, the whole retail world is becoming increasingly digital and decentralized. Shopify is the company empowering this entire movement. They build the tools which enable retailers of all shapes and sizes to succeed in this direct, decentralized retail world. So, as the direct, decentralized retail trend grows, so will Shopify.

At the same time, gross margins in this business are around 60%. Big growth should drive positive operating leverage and result in sizable profit margins at scale.

SHOP stock also shines among its e-commerce peers. While the shares have climbed almost 145% in 2019, the Global X E-commerce ETF (NASDAQ:EBIZ), which has Shopify stock as its eighth-biggest holding (4.37%) among its 40-stock portfolio, has gained 29%. The otherwise-hot British e-commerce/logistics stock, Ocado Group (LSE:OCDO) is that exchange-trade fund’s #2 holding and up just about 55% in the period.

Big picture: Shopify is in the early stages of a huge profit growth narrative, the likes of which will power SHOP stock higher long term.

Interim Volatility Will Persist

Long-term winners don’t go higher in straight lines. Instead, they often suffer from periods of over-hype as the valuation sprints ahead of the fundamentals. The fundamentals spend the next several months trying to catch up to the stretched valuation. During these periods, long-term winners tend to go sideways.

That is exactly where Shopify stock finds itself today.

The fundamentals underlying Shopify stock remain robust. The company is still firing off huge volume and revenue growth rates. Gross margins are largely stable. Operating margins are improving with scale. All things are moving in the right direction for Shopify.

But, Shopify stock also trades at about 350 times next year’s earnings estimates. That’s a rich multiple. Sure, some of the richness is warranted by the company’s promising growth prospects. But, not all of it.

By my numbers, Shopify can reach $25 in earnings per share by 2030, under optimistic yet reasonable growth assumptions. Based on an application software sector-average 35x forward earnings multiple, that equates to a 2029 price target for Shopify stock of $875. Thus, there’s huge upside here in a long-term window.

But, if you discount that 10-year-forward price target back by 10% per year, you arrive at a 2019 price target for Shopify stock of ~$340. That’s where shares trades hands today, implying that further fundamentally supported upside from here is limited.

Bottom Line on SHOP Stock

SHOP stock is a long-term winner. Over the next decade, this stock has an opportunity to soar toward $1,000, thanks to a broad pivot across the entire retail market toward direct, decentralized commerce.

But, in the interim, the valuation has sprinted ahead of the fundamentals, and the fundamentals will spend the next several months trying to catch up to the valuation. As they do, shares will remain volatile and unpredictable.

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

Article printed from InvestorPlace Media, https://investorplace.com/2019/12/interim-volatility-shopify-stock-persist/.

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