Like every business that largely depends on American customers, Shopify (NYSE:SHOP) will face two possibilities starting in May. Specifically, either life will gradually start to go back to normal in the U.S. or the mass closures of businesses will continue in the country. Although I believe that Shopify is much better positioned than brick-and-mortar retailers to withstand the mass closures, I think that Shopify stock is overvalued in either case.
Let’s take a look at how Shopify is likely to fare in each scenario.
Life Gradually Returns to Normal
On April 1, Shopify reported that its “momentum” from 2019 had “continued into January and February.” Theoretically, if life in the U.S. starts returning to the status quo, the company’s business will gradually return to its previous, highly successful levels.
But unfortunately, that theory is flawed because the American economy, and for that matter, the world’s economy, is unlikely to immediately snap back to the level it had attained before the coronavirus crisis. Instead, the economy will, at best, probably be growing much more slowly than it did before the crisis, as some businesses will take time to ramp up and others will have gone bust.
And since unemployment will be much higher as we emerge from the crisis than it was before the outbreak, many businesses will generate much lower sales than they did in the pre-pandemic days. All of those factors will negatively affect Shopify’s financial results.
Further, the small- and medium-sized businesses that make up the core of Shopify’s customer base will feel the worst pain. (In 2019, Shopify Plus, which caters to large businesses, generated 27% of Shopify’s monthly recurring revenue. The metric indicates that 73% of its monthly recurring revenue came from SMBs.)
Valuation Remains High
Many of these businesses likely get much of their revenue from brick-and-mortar retail stores that have been closed during the crisis. Despite help from the government, a meaningful proportion of them will likely go under. Some SMBs will try to stay afloat by launching e-commerce businesses through Shopify. But the revenue the company gets from those new customers is unlikely to offset the sales it will lose as a result of the bankruptcies of its current customers.
Despite the challenges that Shopify will face if this scenario unfolds, SHOP stock is still down just 10% in 2020. Moreover, the shares are still up 84% over the last year. That compares to 23% and 19%, respectively, for Global X E-commerce ETF (NASDAQ:EBIZ).
And the stock’s valuation remain sky-high. Specifically, its trailing price-sales ratio stands at a huge 30.
Not a Good Scenario
This scenario would be a double-edged sword for Shopify. If the country chooses this course, a huge proportion of Shopify’s core customers would go bankrupt. But on the other hand, tens of thousands of new small- and medium-sized businesses, desperate to try to stay afloat by expanding their e-commerce revenue, would sign up with Shopify.
Still, in this scenario — which, by the way, I consider to be unlikely — the economy would likely enter a steep recession or a depression. Consequently, the online sales of most of Shopify’s customers would likely tumble sharply due to weak demand, causing Shopify’s results to plummet. There’s no doubt that, given SHOP stock’s extremely high valuation, shares would drop sharply in this scenario.
Bottom Line on Shopify Stock
Even before the coronavirus crisis, I thought that Shopify stock’s valuation was excessive, given the company’s lack of profitability. With the crisis poised to deliver a big hit to the firm’s core customer base and the shares still up on the year, I’m even more cautious about the stock’s outlook now.
If SHOP stock drops to $270 or below, long-term investors should buy the shares. Unless that happens, I’d recommend staying away from Shopify.
Larry Ramer has conducted research and written articles on U.S. stocks for 13 years. He has been employed by The Fly and Israel’s largest business newspaper, Globes. Larry began writing columns for InvestorPlace in 2015. Among his highly successful, contrarian picks have been GE, solar stocks and Snap. You can reach him on StockTwits at @larryramer. As of this writing, he did not own any shares of the aforementioned companies.