E-commerce solutions provider Shopify (NYSE:SHOP) is set to report fourth quarter numbers before the market opens on Wednesday, February 12. Those numbers should be pretty good — like really good. But, Shopify stock is up more than 50% since the company last reported earnings. All of that gain has come in anticipation of strong fourth quarter numbers, since shares actually dropped on disappointing third quarter numbers.
So, there’s one big question heading into Shopify’s fourth earnings report that needs to be answered. Are really good numbers enough to justify a 50% gain in Shopify stock over the past three months?
Tough to say. But I’d say no.
To be clear, I’m a huge bull on Shopify stock, and have been for a long time. I think this company is pioneering fundamental and disruptive change across the entire retail ecosystem. Long term, this company has a ton of growth potential.
But, here and now, shares are fully priced for all that growth potential. And then some. Even perfect fourth quarter numbers might not be enough to push shares higher.
As such, I think the game plan with Shopify stock is simple. This is a long-term winner that’s overvalued in the near-term. Book some profits. Let volatility do its thing. Let valuation friction rear its ugly head. Buy big dips. Hold for the long haul.
Shopify’s Numbers Will Be Good
It’s pretty clear that Shopify’s fourth quarter numbers will be really good.
Shopify sells e-commerce solutions to mostly small-to-medium sized merchants and retailers from all across the globe. There are two secular trends propelling this growth narrative. First, the secular shift from offline to online retail shopping. Second, the secular shift toward decentralized shopping, wherein consumers buy items directly through the websites of various small-to-medium sized retailers (which is being enabled by the internet, since the internet makes every retailer’s website just one click away).
Both of these trends have tremendous momentum at present. They didn’t lose any of that momentum in the fourth quarter. If anything, both trends gained momentum over the past few months.
On the online shopping front, the fourth quarter and holiday season were record ones for e-commerce. According to Mastercard (NYSE:MA) data, holiday e-commerce sales rose a whopping 18.6% to account for a record-high 14.6% of total retail sales. Meanwhile, according to the U.S. Census Bureau, fourth quarter e-commerce sales rose 13.2%, far higher than the 8.4% growth rate reported in the fourth quarter of 2018. Target (NYSE:TGT) reported a robust 19% rise in holiday comparable digital sales. Amazon (NASDAQ:AMZN) also reported robust e-commerce growth during the fourth quarter.
Meanwhile, it’s clear that as consumers shopped online more this holiday season, they spent more time and money on various small-to-medium sized retailers’ websites. Shopify reported that its Black Friday through Cyber Monday sales rose 61% year-over-year, or more than three-fold the holiday e-commerce growth rate.
All in all, it’s clear that the two trends underpinning the Shopify growth narrative, remained robust in the fourth quarter, and that lays the foundation for this company to report blockbuster fourth quarter numbers.
Shopify Stock Is Too Richly Valued
The problem with Shopify stock is that blockbuster fourth quarter numbers may not be enough to shoot shares higher.
That’s because this stock is very richly valued. To be clear, I’m not one of those valuation bears who has been screaming that Shopify is overvalued for several years, while it has climbed from under $100 to nearly $500. Indeed, during most of that run, I’ve said the valuation is supported by robust long-term profit growth potential.
But, at a near $500 price tag in early 2020, I don’t feel that this is the case anymore. Long-term profit growth prospects do not justify today’s valuation.
Assuming that e-commerce sales rise to account for 30%+ of total retail sales by 2030 (from about 14% today), that Shopify grows e-commerce market share to somewhere between 5% and 7.5% by then (from less than 2% today) and that the company leverages sustained huge revenue growth to drive significant operating margin expansion to about 30% (from about 1% today), then my modeling suggests that Shopify’s earnings per share will land somewhere between $25 and $30 by 2030 (versus consensus estimates calling for 90 cents in 2020).
Those are optimistic assumptions, and that’s a ton of growth. Still, it’s not enough to warrant today’s price tag.
Based on a 35-times forward earnings multiple — which is the medium-term average forward multiple for application software stocks — $27.50 in 2030 profits per share implies a 2029 price target for the stock of $962.50. Discounted back by 10% per year, that equates to a 2020 price target of about $410.
Shopify is a great company. Shopify stock is perfectly valued. That’s not a great combination heading into earnings. The numbers will likely be very good, but they may not be good enough to push shares higher. As such, while I like Shopify stock long-term, I’m cautious on shares in the near-term, or until they come back to more tangible valuation territory.
As of this writing, Luke Lango did not hold a position in any of the aforementioned securities.