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Don’t Let the Red Ink in Shopify Stock Tempt You

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Last month, online merchant place Shopify (NYSE:SHOP) disclosed two major announcements. First, the company acquired 6 River Systems, which utilizes cloud and robotics technology to make fulfillment solutions more efficient. Second, Shopify finally allowed its merchants to sell cannabidiol (CBD) products in legal jurisdictions. In theory, both announcements should bolster SHOP stock.

Source: BalkansCat / Shutterstock.com

Of course, the best theories don’t always pan out in real life. Due to the funds needed to secure the 6 River acquisition, investors read between the lines. While Shopify stock is very much a growth name, the underlying company has so far only produced a string of annual net losses. Therefore, the acquisition makes the premium on SHOP even more stretched.

However, one could make the argument that this dynamic represents a buying opportunity for Shopify stock. Our own David Moadel did exactly that, stating:

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I like to think differently than 99% of investors; if they’re all selling, I’m looking for a buying opportunity. When it comes to SHOP stock, I now view it not only as an investment in e-commerce, but as a stake in the cloud and robotics niches — both of which have a bright future, in my ever-so-humble opinion.

I respect Moadel’s logic. For one thing, SHOP stock has absolutely killed it in the markets. More fundamentally, though, Shopify is emblematic of the digitalization of commerce and its disruptive capacity. Like Square (NYSE:SQ) has done for payment processing, SHOP can level the playing field for small merchants.

At the same time, I don’t think you can ignore context. And in my view, the current (and coming) environment doesn’t bode well for Shopify stock.

A Reality Check for Shopify Stock

While Moadel and SHOP bulls see longer-term opportunities, I’m more focused on the nearer-term risks. Additionally, I perceive a hint of desperation with last month’s news. Let me explain:

On the surface, the 6 River acquisition makes perfect sense. As a force-multiplier for the fulfillment process, Shopify can help its merchants better serve their customers. With over 800,000 global merchants, that’s a sizable consumer base. Again, in theory, this should lift Shopify stock.

However, it’s important to ask a follow-up question: how many of the company’s merchants are generating enough business to justify the 6 River acquisition? When you break down the numbers, the average gross merchant volume for SHOP’s merchants averages less than $60,000.

But that’s just the average. Clearly, most standalone businesses can’t survive on GMV of $60,000. Logically, then, an investment in SHOP stock is an investment in a relatively few core clients; the rest of them will succumb to Shopify’s churn rate, which they don’t publish. Go figure.

In my view, management knows exactly what they’re doing. They realize that currently, investors are buying on perception rather than fundamentals. That’s why I’m cynical about the CBD merchant approval. Naturally, this move will boost the merchant base – and possibly SHOP stock – but what’s the success rate for CBD retailers?

Undoubtedly, many will succeed. But many more will surely fail. As Dr. Andrew Kerklaan, president and founder of Dr. Kerklaan Therapeutics stated, “The days of bootstrapping a start-up in the cannabis industry are quickly coming to an end, if not already over.”

In other words, what matters most is capital, not wide-eyed entrepreneurs with a dream. Right now, Shopify has more of the latter than the former. This is why I’m not crazy about Shopify stock at the present valuation.

SHOP Stock Faces Macro Headwinds

As SHOP states in their blog page, the appeal for the merchant place is discovery. Shopify allows small businesses to find consumers that are looking for authentic products and excellent customer service. That might work in a bull market. But heading into a possible bearish phase, I’m not sure if this business model is conducive for SHOP stock.

Recent data suggests a crack in consumer sentiment. Spending growth has slowed, leading some economic experts to raise a yellow flag.

And you don’t have to deep dive consumer data to get the chills. Despite a trade truce, a trade deal between the U.S. and China is still far off. Plus, geopolitical tensions, particularly in the Middle East, threaten to disrupt global economic sentiment. If these factors weren’t enough, our own politics is fraught with mistrust and division.

Simply put, it’s not a great time for companies levered to discretionary retail. Additionally, if consumers are going to buy anything in a distressed environment, they’ll do so cheaply. That means companies that have the scale to provide quality goods cheaper – we’re talking Walmart (NYSE:WMT) and Target (NYSE:TGT), among many others – will leapfrog small businesses that specialize in niche products.

Sure, authenticity and good service matters. But when push comes to shove, it’s all about the Benjamins. Most of Shopify’s merchants don’t have the scale, which means you should let SHOP stock cool even further.

As of this writing, Josh Enomoto did not hold a position in any of the aforementioned securities.

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