Take Profits On Shopify

| About: Shopify (SHOP)

Summary

Shopify enjoys blistering growth.

Shopify is on the cusp of profitability.

But Shopify valuation is extreme.

Investors have had a good ride. It is time to take some profits.

There is little doubt Shopify (SHOP) is a great company. The question is whether it is good value at today's stock price. That is a more difficult question to answer.

Shopify revenues seem likely to beat $600 million this year and growth should better 40 to 50% at annual rate for a few years yet. Expenses are rising as well putting the company at a break even level more or less. How do you value a fast growing company that is on the cusp of profitability? With caution, in my view.

A reasonable way to value rapid growth in the technology space is to use a multiple of sales. The number of very successful technology based companies that took years to turn in a profit of any magnitude is legion. Notwithstanding, investors will buy into a story that has a robust underpinning even if that means a long wait before multiples of net income or free cash flow make any sense.

I think the best valuation of Shopify will come from comparison with other technology companies who have followed or are following a somewhat similar course of growth. In the ecommerce space, the comparables I suggest are Go Daddy (GDDY), Salesforce.com (CRM), and, Amazon.com (AMZN). All three are growing quickly; all three have grown quickly with little in the way of profits; and, all three comprise stalwarts in the ecommerce space. Of the three, Go Daddy is the most comparable to Shopify in that like Shopify, Go Daddy facilitates online commerce for third parties including most elements of on-line commerce management.

Stock

2017 estimated sales (millions)

Market Capitalization
(billions)

Growth rate
(%)

Price to sales ratio

GDDY

$2,220

$8

22

3.97

CRM

$12,450

$68

24

7.24

AMZN

$174,000

$475

28

3.17

SHOP

$648

$12

40

23.37

Source: Yahoo.com finance

Shopify is a young company with a strong ecommerce platform and is turning in impressive growth figures. Growth at 40% or more is difficult to sustain for any long period of time and it is unreasonable to believe that torrid pace will persist for more than few years. In my view, investors should expect Shopify growth to ameliorate to the mid-20% annual rate within the next five years. By that time, the company will be a $2 to $2.5 billion annual sales company and, in my opinion, will enjoy a price to sales multiple of 4 to 5 times, putting a market value on the company of $8 to $13 billion.

The market already values Shopify at $12 billion. That valuation carries very high execution risk. I like the company and see real value in its comprehensive set of ecommerce applications and tools. Having said that, I would take some money off the table.

It is worth noting that in Shopify's public offering, the owners priced the company at a small fraction of its current market value and did so only a bit more than two years ago. Investors have done well and seen their stock rise eight-fold since issue despite suffering over 90% dilution based on the offering price. At the time of the IPO, it is reasonable to infer that management viewed the offering price as "fair value" and have done a very good job executing the plan they laid out for investors. But there is little reason to believe that management underestimated the potential for the company such a short time ago, and less reason to believe that the current value is sustainable.

Shopify is a market favorite and I don't see a lot of risk that the stock price will collapse if the company continues to perform, and I think it will. The risk to investors today is simply that they are unlikely to earn a return commensurate with the risk in the stock.

I rate the stock a "hold". Momentum seems strong and barring a disappointing quarter, the stock is more likely to rise short term than to fall. But, over time, value will merge with stock price and investors should expect only modest returns from today's elevated price.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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Tagged: , Specialty Retail, Other, Canada
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