Shopify (NYSE:SHOP) has done extremely well this year, both financially and for its shareholders. For example, Shopify stock is up over 250% in the last 12 months, and it has rallied 166% in 2020.
Shopify provides a multi-channel platform for online sellers. Its earnings and sales have grown rapidly in the past several years.
However, the valuation of Shopify stock is very stretched right now. In fact, the shares have a forward price-earnings ratio of 476 times. Meanwhile analysts polled by Seeking Alpha,, on average, expect its earnings per share to fall from $2.42 this year to $2.22 next year.
The stock is trading at a massive valuation. Moreover, its price-sales ratios are high enough to be outlandish even if they were P/E ratios.
For example, the stock’s P/S multiple, based on analysts’ average 2020 sales estimate, is almost 50 times. The same ratio, based on the average 2021 revenue estimate, is about 38 times.
Further, TipRanks.com reports that there are 26 analysts whose average price target on Shopify stock is not much higher than the shares’ price today.
These analysts have all issued notes on the stock in the last three months and have produced 12-month price targets. Their average price target is $1,133.15. That is just 7% above yesterday’s closing price of $1,056.
Another website, Marketbeat.com, reports that there are now two “sell” ratings on Shopify stock and that the average price target on the shares from analysts it polled has dropped to $1,021.59. That number is over 4% below the stock’s current price.
Sell-Side Analysts and Shopify Stock
I always take analysts’ ratings on a stock with a grain of salt. Investors have to do their own research, as they can easily go dizzy following sell-side analysts’ advice.
For example, if you think that a stock is a bargain, you will often find that many analysts have a “sell” rating on it. But if a stock’s valuation is too high after rising a good deal, many analysts will often have “buy” ratings on it.
Recently, however, one analyst seems to have the right idea about Shopify. Specifically, Barron’s reports that Morgan Stanley analyst Keith Weiss thinks that Shopify is a great success story. But he says that track record is already priced into Shopify stock.
He cites his analysis that the stock trades for 23 times his forecast of its free cash flow in a decade. By contrast, Amazon (NASDAQ:AMZN) trades at 23 times the analyst’s 2023 free cash flow estimate.
What To Do With Shopify Stock
This is a very high-priced stock with a stretched-out valuation. Investors are probably better off avoiding the stock until it drops. That will give them a chance to buy it at a lower valuation.
One way to potentially avoid paying such a high price for the stock is by shorting cash-secured puts at relatively low prices – i.e., prices that are “out-of-the-money”. By shorting puts at prices well below the present stock price (i.e, out -of-the-money) investors can pick up extra cash. If the stock falls, you get the opportunity to buy the stock at the lower strike (i.e, exercise) price at which you shorted the put.
You can also use a credit-spread strategy. For example, investors can sell short the Jan. 15 puts that have a strike price of $1,000 and receive $81 per share. At the same time, they can buy a put with a $960 strike price for $65.50 per share. This latter trade acts as a hedge.
The credit spread on that strategy is $15.50 i.e. the difference between the two options’ debit and credit. Therefore, the net-credit spread for 100 shares of each type of option is $1,550. The most you can lose on that trade is $4,000 (i.e., the difference between the value of the $1,000 puts you sold and the value of the $960 puts you bought times 100). However, since you would make $1,550 because of the spread, the maximum potential loss is $2,450.
This strategy lets you keep the full $1,550 as long as Shopify stock stays above $1,000 until Jan. 15. At that price, depending how much time is left on the contract, you might have to buy back the put contracts you sold. This might mean giving up some of the $1,550 you received from selling the put options.
You make money in this strategy by (1) receiving the net $1,550 credit spread, as long as the stock stays above $1,000 by Jan. 15, and (2) As long as the stock stays above $984.50, you will still make some money.
If the shares fall below that price, the maximum you can lose is $2,450. However, you will still own 100 shares of SHOP stock and you can then sell covered calls which will allow you to make a profit.
This is known as the “wheel” option strategy. Here is an easy video that helps you understand how to execute it. This is an easier way to play Shopify stock than buying it at today’s overly stretched price. By shorting the put below the present price, you guarantee that you will be able to buy it at a lower level.
On the date of publication, Mark R. Hake did not have (either directly or indirectly) any positions in any of the securities mentioned in this article.