There's no denying Shopify (NYSE:SHOP) has shocked the world. SHOP stock is up more than 165% in 2019, and Shopify stock has rallied an incredible 2000% since its 2015 IPO by doing what many said can't be done. That is, penetrating an e-commerce market dominated by Amazon (NASDAQ:AMZN).
SHOP's magic formula has been behind the stratospheric surge of SHOP stock. That formula involves empowering online merchants with tools and information that eBay (NASDAQ: EBAY) and Amazon don't exactly want their sellers to have. The fact that 5,300 companies are using Shopify's products shows that it's got what businesses want.
The enthusiasm of the owners of SHOP stock is understandable.
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The huge rally of Shopify stock in just the past few months, though, has left SHOP stock uncomfortably vulnerable to profit-taking and short-selling. Shopify's growth doesn't justify the current valuation of SHOP stock.
Shopify Validates the Business Model
For ages, investors have argued about how far into the future they should look.
Amazon is the obvious poster child for an answer along the lines of "many, many years." It was a habitual money loser since its inception in 1994, and didn't start turning consistent profits until 2015. But, now that it's in the black, it's tremendously in the black.
Shopify may well be on a similar path.
There's a dangerous difference between Amazon then and Shopify now, however. Then, it wasn't entirely clear that e-commerce could ever be profitable. Now, with the industry fully matured, it clearly can be profitable. As a result, many companies with new approaches will enter the sector, while established players like Walmart (NYSE:WMT) are stepping up their game.
SHOP, in fact, is one of those newcomers. It's the un-Amazon. It's not even eBay facilitating the establishment of truly independent e-commerce platforms.Others will follow.
Shopify Stock Really Does Have a Valuation Problem
This competition won't be problematic for Shopify stock, though. Indeed, even though Shopify's 10% share of the all-in-one e-commerce platform market is less than that of WooCommerce's and Squarespace, SHOP has arguably already won the battle for mind-share. It should be the market leader, sooner or later.
As of the most recent look, however, SHOP stock, with a market cap of $44 billion, is valued as 34 times its trailing 12-month revenue of $1.3 billion. That's not 34 times its earnings, to be clear, which would be considered frothy by most standards. That's 34 times revenue
SHOP stock reached that huge valuation even though SHOP wasn't consistently profitable until last year. Based on this year's projected profit of $69 million, SHOP stock is valued at 637 times SHOP's earnings.
That's not necessarily the end of the world. Shopify is a work in progress. The market has rewarded less successful names, with less promising prospects.
But the point where the current SHOP stock price of $369 will be justified is so far down the road that it can't actually be seen. The 2021 outlook for revenue of $2.7 billion and net income of $218 million still leaves Shopify stock valued at 16.3 times the company's sales and more than 200 times its earnings.
On average, stocks are valued at three times companies' revenue, and between 15 and 20 times their earnings.
Most people don't realize that the current valuation of Shopify stock isn't justified. It's all based on hype, rooted in the premise that somebody finally figured out how to beat Amazon at its own game. Shopify would have to obliterate its estimates for the next several years to justify the current price of SHOP stock (let alone a higher price) at a time when competitors are improving their own products.
The Bottom Line on SHOP Stock
I'm not suggesting SHOP stock is destined to immediately roll over and lose a big chunk of its value.
It's entirely possible - even likely - we're at the start of something of a melt-up, as the fear of missing out on continued rallies by Shopify stock pulls more buyers into the incredible rally. Things like fundamentals don't matter until the majority of traders decide they matter, and right now, they don't matter for Shopify stock. A short squeeze may also be in play, artificially pushing the shares higher.
Make no mistake though. Every stock always eventually reflects tangible value. Even on a risk-adjusted, potential-adjusted basis, SHOP stock is already in jeopardy.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities. You can learn more about James at his site, jamesbrumley.com, or follow him on Twitter, at @jbrumley.
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