Shopify (NYSE:SHOP) has enjoyed a stellar runup in the past three months. As of Aug. 10, SHOP stock was at $1,525.94 with a $190.4 billion market capitalization. This was up 45.6% from its May 13 low close at $1,047.77, probably in anticipation of the company’s Q2 earnings.
The problem is Shopify stock now trades at a mind-numbing altitude of 343 times adjusted earnings per share (EPS) based on analysts’ 2021 forecasts. That is simply too high for most value investors or even growth investors that want to buy in at a reasonable price. Given its recent runup, investors are likely to wait for SHOP stock to dip to a lower price.
Where Things Stand at Shopify
Even using estimates for 2022 earnings from Yahoo! Finance, the stock is still expensive. It trades for 306 times the $4.99 adjusted net EPS estimate for 2022. This is simply astronomical. The valuation is not tethered to any kind of reality.
However, there are several good things to point out about the company’s growth. For one, its 57% year-over-year (YOY) growth in sales during Q2 (released on July 29) was impressive. Sales reached over $1 billion for the first time in a quarter to $1.119 billion.
Moreover, its gross merchandise value (GMV) was at an all-time high of $42.2 billion. This implies that its “take rate,” the ratio of revenue taken from the GMV of items sold, was 2.65% ($1.119 billion / $42.2 billion).
That is a respectable take rate, but certainly not as good as eBay (NASDAQ:EBAY) which last quarter had a 10.9% take rate. Amazon (NASDAQ:AMZN) does not provide its GMV, but PayPal (NASDAQ:PYPL) has a 2% take rate. Both eBay and PayPal trade for significantly lower forward P/E ratios (15x and 47x, respectively). In other words, Shopify’s basic business model, with its below-average take rate, does not deserve such a stratifying high valuation.
Free Cash Flow is Falling
Maybe the company has an incredible bottom line. But here again, Shopify is lacking. In Q2, the company made free cash flow (FCF) of just $58.1 million.
This can be seen in the Seeking Alpha historical quarterly cash flow statements data. The cash flow from operations was $66.4 million, and after subtracting $8.3 million in capital expenditure spending, the FCF was $58.1 million. This was about half of the Q1 FCF of $130.5 million. In other words, FCF is falling but the stock is flying high. Its FCF margin is lower, but the P/E is higher. Something does not add up here.
For example, according to the company’s own cash flow statement, it made $202.1 million in cash flow from operations in its first six months. After deducting $13.45 million in capex, the six-month FCF performance was just $188.65 million, or 8.95% of its six-month revenue. This implies its full-year FCF will be $397.4 million, or 8.95% of its forecast $4.44 billion in revenue. We can use this to properly value SHOP stock.
Typically growth stocks will be valued at an FCF yield of 1%. Here is how that works. If we divide the $397.4 estimate for this year by 1%, we get a target market cap of $39.74 billion. But Shopify has a market cap of $190 billion. In other words, it is wildly overvalued on an FCF basis, or bottom-line basis.
What To Do With SHOP Stock
So if we can’t use earnings, take-rates, and free cash flow to come up with a valuation anywhere near today’s market value, maybe we can use sales. But here again, Shopify trades in the stratosphere.
For example, Yahoo! Finance indicates analysts forecast that sales will reach $4.44 billion in 2021 and $5.91 billion in 2022. So at $190.4 billion, its market cap is 42.9 times 2021 sales and 32.2 times 2022 sales. This is also probably at least 100% too high compared to any other comparable growth company this size.
Even if it was only 50% too high, SHOP stock would be trading for 21.5 times 2022 sales (32.2 / 150% = 21.5). This implies that SHOP stock is worth at least 33% less than today (1 – 32.2/21.5 = 33.2%). That gives it a “reasonable” value of just 1,019.33 per share.
Therefore, most value investors will wait until the stock falls at least one-third, just to know that they bought in at a price reasonably tethered to some value metric.
On the date of publication, Mark R. Hake did not own any security mentioned in the article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Mark Hake writes about personal finance on mrhake.medium.com and runs the Total Yield Value Guide which you can review here.
