Shopify Inc. (SHOP, Financial) is a Canadian technology compan that has become a cornerstone for commerce on the internet and a “can’t live without” service for small and medium-sized businesses. That’s a fact, and that’s what makes it a great business. However, as witnessed from the latest quarterly report, Mr. Market continues to be too happy with its valuation.
Unpacking Shopify’s recent results
On Wednesday, Shopify reported its fourth quarter and full year financial results, and the company showed that it continues to grow. Fourth quarter revenue was up 25% year-over-year, beating Wall Street's estimates by $80 million, even though Shopify continues to lose money on a GAAP basis. However, the non-GAAP earnings number was positive at $0.07 per share.
Full year results tell a different story. Total revenue came in 21% higher than the 2021 mark at $5.6 billion with an operating loss of $822 million. The worst news? Top line growth is slowing, down big from the 57% gains Shopify saw in 2021. The growth didn’t slow down across Shopify's operating expenses, with the company spending $1.7 billion on selling, general and administrative costs and nearly $1.5 billion on research and development.
One of the more positive statistics from Shopify is that gross merchandise volume across all merchant stores for the year was $197 billion. That is the total dollar value of all orders processed on the Shopify platform, net of refunds. It’s a big number. For context, Amazon (AMZN, Financial) had $611 billion worth of gross merchandise volume in 2021, with $390 billion from third-party sellers. Shopify is not that far behind Amazon based on this metric; however, that alone doesn’t justify a market capitalization of $57 billion.
In fact, despite the stock being down 74% from its 2021 high, the stock remains overvalued on several metrics and faces a significant number of risks going forward. Most importantly is the question of sustainable growth. While Shopify’s historical rate should not be taken for granted, the company simply cannot grow its top line at 50% a year like it could in the past. What’s more likely to happen is that revenue growth will continue to slow and eventually get down close to single digit rates by the end of the decade.
Shopify’s business model is fantastic
Shopify is the leader in its niche. It provides a comprehensive solution for retail businesses specifically operating in e-commerce through a user-friendly and powerful platform, complemented by various additional features such as its own fulfillment network.
One of the main benefits of Shopify is ease of use. The platform provides a wide range of customizable templates and themes to help businesses create a professional-looking online store quickly and easily. It also offers a variety of tools and features to manage and track orders, process payments and handle shipping and returns. Collectively this creates an end-to-end solution for small and medium-sized businesses (SMB). Shopify has established a sizable competitive advantage, as switching to a new payment and store management solution is both hard to do and extremely costly, which for SMBs makes it almost impossible. There are other options, even DIY ones that are great (like Wordpress and WooCommerce) that could eventually combine to better compete for Shopify's customers.
Another advantage of Shopify is its scalability. The platform is designed to grow with a business, and offers a range of plans to accommodate businesses of all sizes. It has over one million merchants who sold to more than 560 million shoppers last year alone. The platform primarily caters to small and midsize businesses, specifically targeting those with 500 employees or less, especially solopreneurs and dropshippers, but it also has large multinational corporations like Kraft-Heinz (KHC, Financial), Lindt, and Red Bull who use it. There’s definitely potential for it to capture more big name clients, it just won’t need them to stay successful.
Shopify is still overvalued right now
There is no doubt in my mind that Shopify is an incredible business, helping bring a better experience to hundreds of millions of shoppers worldwide. That said, the stock is not a good value at a price-sales ratio of 10 with slowing growth and extremely high operating costs. I think a more appropriate value would be closer to three to five times sales, and that means a market capitalization closer to $25 billion. If the growth rate slows much more though, that number could fall or stagnate. On the other hand, if Shopify could consistently get R&D and SG&A costs down to reasonable numbers, it would be more fairly valued.
Profitability is still in question in the long term, even with its huge network effect. Yes, Shopify has a substantial net cash position of $4.1 billion, but its capital allocation is suspect. The company really hasn’t been focused on building value, and it shows when you read the annual reports and look at the financial statements. Shopify has been around since 2006, which is plenty of time to figure out how to turn a profit; however, I am afraid that its trend of being unprofitable continues for now. Growth is slowing and the expenses keep rising faster than revenue. A great business does not always make a great investment.
