You don’t have to look far to see the bull case for Shopify (NYSE:SHOP). Even intuitively, we all recognize that ecommerce has revolutionized the retail industry. Given the dramatic, long-term success of Amazon (NASDAQ:AMZN) and its ilk, it’s only natural that Shopify stock receives positive coverage.
Source: Shopify via Flickr
Earlier this year, our own Chris Lau boldly proclaimed that SHOP stock “should have another great quarter.” He hit it spot-on. For the fourth quarter of 2018, Shopify produced adjusted earning of 26 cents per share. This was up five cents above the consensus forecast, and represented over 73% growth year-over-year.
More important, management delivered $343.9 million in revenue, topping the consensus target calling for $327 million. Impressively, this latest haul exceeded the year-ago sales tally by a whopping margin of over 54%. Unsurprisingly, the SHOP stock price skyrocketed this year, up nearly 43%.
At the same time, it’s hard not to find some critical voices. For instance, InvestorPlace contributor Vince Martin wrote an excellent piece about the valuation risks regarding Shopify stock. Since the company has cyclical challenges, an ever-rising share price presents an uncomfortable proposition for speculators. Plus, as Lau mentioned, Shopify still is losing money.
However, the bulls overcome these oft-cited vulnerabilities due to the forward-looking opportunities. As we’re told repeatedly, e-commerce as a sector is growing exponentially. As it relates to Shopify stock, the underlining company continues to add members thanks to its user-friendly platform.
Furthermore, stakeholders may potentially benefit from the cannabis legalization, and management’s international ambitions. Success in either category could reignite the SHOP stock price.
But behind most optimistic scenarios is a narrative. Whether that story comes true or not is an entirely different matter.
Markets Warn Against Shopify Stock
I’m not interested in providing another narrative; I’d like to look at the hard data. Make no mistake about it: Shopify stock proved to be one of the most profitable initial public offerings in recent memory. A major reason why is because of the ecommerce firm’s meteoric sales growth.
From Q2 2015, revenue jumped from just under $45 million to nearly $344 million in the most recent quarter. Over the same timeframe, the average SHOP stock price jumped from $30.56 to $143.09. Mathematically, this represents a correlation of 94%. In other words, as revenues increased, so did the share price: not rocket-science.
Interestingly, though, the correlation between sales and share prices dipped to about 54%. True, this is a much smaller sample size, which can create distortions. Nevertheless, the reduction in the relational strength between revenue and market value warrants investigation.
As it turns out, Shopify’s revenue in terms of percentage growth has consistently declined over the years. For example, in Q4 2016, sales growth was 85.8%. One year later, this metric slipped to 70.9%. In the most recent Q4 as we mentioned, growth is at 54%. In that context, the last earnings report wasn’t that impressive.
Not only that, the free market generally reflects this revenue decline. In 2017, the average YOY growth in the SHOP stock price ballooned to nearly 158%. Last year, it settled down to a comparatively more reasonable 67%.
But I believe this average share-price growth rate will decline further. Keep in mind that Shopify stock is a growth investment. Obviously, you’re not earning dividends here. So if the growth narrative starts to falter, speculators have less reason to tolerate risk.
As you can see, the growth curve only points in one direction: down.
It’s Time to Take Profits
If you’ve benefitted from the latest surge in Shopify stock, congratulations! Now is the time to secure those benefits, turning a “paper” victory into a real one.
As Martin repeatedly states for SHOP and other investments, valuations matter. In this case, you’re paying a hefty premium for declining growth. That doesn’t side like a wise move. To me, it sounds like a mini-bubble, that emotions have trumped the fundamentals.
And let’s talk about those fundamentals. Shopify largely wins off small and medium-sized businesses. But is that enough to sustain the rich premiums for SHOP stock? I’d argue no.
In fact, the declining sales growth rate confirms that other factors, like competition and a narrow consumer base, have chipped away at Shopify’s armor. With shares up 43% year-to-date, your next move is an obvious one: take the money, and wait for a better re-entry point, if you wish.
As of this writing, Josh Enomoto did not hold a position in any of the aforementioned securities.
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