Shopify (NYSE:SHOP) stock has shot up over 90% so far in 2020. That is an incredible, market-beating performance. In fact, it is up over 253% in the past year. But this success is too much, too fast. Shopify stock looks overvalued here.
To be fair, Shopify posted a first-quarter profit of 19 cents per share that analysts did not expect. In addition, revenue was up much higher than expected. Barron’s called these developments a “surprise.”
Moreover, Barron’s also reported last week that Canaccord Genuity analyst David Hynes believes Shopify stock is at an “unsustainable extreme.”
To justify his argument, he points out that with Shopify’s existing $83 billion valuation, revenues would have to reach $4.5 billion by the end of 2022. That would give the stock a little less than a 20x times revenue valuation.
But the problem is that revenue, although up 47% year-over-year, was just $470 million in Q1. This is a run rate of $1.88 billion annually. And if you add in a 15% increase for Q4, it is an annual rate of almost $2 billion.
So the 2020 price-sales ratio is now 41 times ($83 billion divided by $2 billion). To get to a 20 times price-sales ratio, revenue would have to grow 212% over three years to $4.15 billion. That implies an annualized growth ratio of 28.6%. That is a very high growth rate to assume over three years.
Is a Higher Growth Rate Even Possible?
Yes, the company could sustain those kinds of growth rates over the next three years. For example, this past quarter, revenue growth was about 9.5% on a last-12-months basis. And this has occurred for the last several quarters, implying a 43.5% annualized growth rate.
Moreover, Shopify reported that its underlying gross merchandise volume (GMV) grew by 46% year-over-year. This is very important since GMV is the basis of how Shopify generates revenue.
Here is how that works: GMV is the value of goods and services purchased on Shopify’s platforms. Shopify gets a “take rate” or commission on GMV, which varies based on which type of plan the merchant has on their Shopify website. The take rate then generates revenue for Shopify.
So as GMV grows — through new third-party sellers and overall increased volume — the net revenue at Shopify grows. The bottom line is that GMV growth looks very powerful. It could possibly sustain a 28%-40% annualized growth rate over the next three years.
Here is one reason why I believe GMV could sustain a 28%-40% annualized growth rate for several years. Last quarter, Shopify reported that its GMV rate for all of 2019 was $61.1 billion. If you annualized the Q1 GMV of $17.4 billion, the LTM run rate for GMV is $69.6 billion. That represents a run rate growth of 13.9% in LTM GMV in Q1 over Q4. So a quarterly growth rate of 13.9%, even if not compounded, is 55.6%.
This shows me that the historical growth in GMV, and therefore revenue, could easily average over 40% over the next three years.
Is Shopify Stock Worth Its Revenue Multiple?
I have shown that revenue at Shopify could easily double within the next three years. But does that mean Shopify stock should be worth 42 times revenue now?
This implies that the valuation multiple will be 20 times revenue by the end of 2023. The problem with this valuation is PayPal (NASDAQ:PYPL), another GMV-type company, is worth just 9.3 times its LTM revenue. Its market value is $170 billion and LTM revenue was $18.26 billion. Even Amazon (NASDAQ:AMZN) trades for just 4 times LTM revenue.
So the market may be overvaluing the high growth rate. Even the Cannacord analyst mentioned above said that 18 months ago a premium valuation would be 12 times revenue, not 20 times.
So while I do not have a problem with the implied growth rate for today’s Shopify valuation, I think the multiple put on that growth rate is probably too high. In short, the stock is priced for perfection.
The Recent Capital Raise Confirms the Premium Valuation
One day after Shopify’s May 6 earnings report, the company announced it was going to raise equity capital. There was no mention of this in the earlier report.
The very next day, Shopify had raised almost $1.3 billion at $700 per share. Now, Shopify had just reported a profit and also showed that it had $2.36 billion in cash on hand. Moreover, this was only $100 million lower than the cash it had on hand at the end of Q4 2019.
So what’s up? Shopify is very smart. You always raise cash when your stock is at a premium valuation. You do the opposite — buy back shares — when it is below its true value.
That is probably the best evidence that Shopify is likely too high in terms of its valuation. Management knew this and decided to take advantage of it by raising unneeded equity capital.
Therefore, I would wait for another, more opportune time to buy Shopify stock. Although it is experiencing solid growth rates, the multiple on that growth in its present valuation is too high.