Shopify Stock Is Showing Echoes of Circa 1999

As Shopify (NYSE:SHOP) continues surging, investors will look back at 2020 as a year of FOMO – the Fear of Missing Out. SHOP stock now up 170% since the beginning of the year and 3,700% since its 2015 IPO, and it’s not alone.

Image of a shopping cart toy on a wooden desk carrying a mobile phone that features the Shopy (SHOP) logo on it

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Tech stocks, led by work-from-home companies, have rocketed to new heights. But with SHOP stock now trading for over 60 times sales, investors are asking themselves if it’s too late to invest.

And they’re right to wonder. Lofty valuations are the basis of stock market bubbles. As Amazon (NASDAQ:AMZN) showed in 1999, even the best companies can quickly become terrible investments if bought at the wrong price.

So, while Shopify will still reward long-term investors, here’s why it’s better to wait for a better entry point.

SHOP Stock: A Beauty Contest Gone Wrong

In 1936, economist John Maynard Keynes likened the stock market to a beauty contest where judges reward the most popular faces, rather than those they personally find most attractive.

A smart judge would consider what other judges prefer (also known as second-level thinking). Even more intelligent judges, meanwhile, would consider what the smart judges are thinking. So much for British beauty contests.

Shopify stock is emblematic of this reasoning. Rather than focus on the company’s underlying value, investors start asking themselves: “Will someone else eventually buy this stock at a higher price from me?”

Why do I say this? That’s because Shopify’s share price no longer reflects its fundamental value. Even aggressive estimates that peg revenues at $54 billion in ten years still struggle to justify Shopify’s $133 billion valuation.

Using those inputs, a two-stage DCF model shows fair value comes to $613, a -44% downside from current prices. Amazon took 13 years to go from $1.5 billion in revenue to $54 billion. For Shopify to justify its current value, the eCommerce platform would have to do that in eight.

High Valuations Prevent Massive Gains

To continue with comparisons to Amazon, consider this: Back in 1999, Amazon looked much like Shopify today.

The company had $1.5 billion in revenue and was the investment darling of the day. And though Amazon’s EBITDA losses were three times larger than Shopify’s in 2019, its revenue grew four times faster.

With the 1999 tech bubble rapidly inflating, Amazon’s shares also reflected a premium valuation. Shares traded at 34 times EV-to-revenue by Q2 1999. (The median company sells at closer to 2.6 times today).

Now here’s where the comparison gets interesting. Buyers jumping in at Amazon’s tech bubble’s peak would have faced colossal disappointment.

AMZN shares plummeted 92% when the bubble burst in 2000 – investors would have to wait over a decade (post-2008 financial crisis) to recoup their losses. And that’s provided they didn’t sell out in the meantime.

Today, Shopify investors face an even more expensive dare. Shares of the eCommerce platform trade at 61 times EV-to-revenue. Of large-cap tech companies, only Zoom Video (NASDAQ:ZM) trades for higher. And therein lies the problem.

With a $135 billion market cap today, Shopify can’t grow 100x without becoming the largest-ever corporation on the planet.

What’s SHOP Stock Worth?

Fundamentally, Shopify is still a phenomenal company. The firm provides an easy-to-use platform where sellers can build an eCommerce site within minutes. And Shopify’s recently created fulfillment services promise Amazon-like speed for shipping and handling services.

The company’s financials also show a healthy underlying business. New stores grew 71% in Q2 2020, while gross merchant value (GMV), a measure of usage, rocketed 119%.

The company is profitable, earning $46 million in the quarter. And margins will continue rising as the company gains scale, but that doesn’t make SHOP stock worth an infinite amount.

Companies from Amazon to Microsoft could yet create a competing product. Or Shopify’s growth could slow once coronavirus lockdowns start lifting.

Reasonably bullish estimates should peg share values around $530/share, or 29 times EV-to-revenue. That provides for Amazon-like growth and a generous 8.5% discount rate.

What Are Better Buys?

Investors looking to scratch their eCommerce itch should consider other high-growth stocks outside the U.S. FOMO bubble. SEA Limited (NYSE:SE), a Southeast Asia eCommerce startup, is growing just as fast.

Its EV-to-revenue ratio sits at 27 times – still a premium valuation, but far cheaper than Shopify’s 61 times. MercadoLibre (NASDAQ:MELI) , Latin America’s version of Amazon, shows similar promise: its stock trades at 22 times EV-to-revenue.

Neither of these stocks is immune to a downturn – a bursting U.S. bubble will still send all highly-valued companies back down to earth.

But these eCommerce companies will fall less than Shopify – they have wider economic moats thanks to the network effects of centralized online marketplaces, and they’re also cheaper.

Let’s return to Keynes’ beauty contest one last time. Shopify might be the most attractive of the contestants right now, but every judge already knows that.

The longer this goes on, the further SHOP stock price will detach from reality. Speculators will make splendid short-term gains as the bubble keeps inflating.

Stock bubbles, however, can’t last forever. The bottom eventually gives out when investors realize there’s no “greater fool” left to buy their shares. And that would send SHOP stock plummeting.

I never like sitting on the sidelines when great companies go by. But today, SHOP stock looks too dear of a bet to take.

On the date of publication, Tom Yeung did not have (either directly or indirectly) any positions in the securities mentioned in this article.

Tom Yeung, CFA, is a registered investment advisor on a mission to bring simplicity to the world of investing.

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