<p>Shopify (NYSE: SHOP) has increased by over 90% so far in 2020. It is an incredible, market performance. In fact, it has increased by over 253% in the last year. But this success is too much, too fast. The Shopify share looks overvalued here.
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To be fair, Shopify posted first-quarter earnings of 19 cents per share that analysts did not expect. In addition, revenues increased much higher than expected. Barron called this development a “surprise.”
In addition, Barron’s reported last week that Canaccord Genuity analyst David Hynes believes the Shopify stock is in an “unsustainable extreme.”
To justify his argument, he points out that with Shopify’s existing valuation of $ 83 billion, revenue would need to reach $ 4.5 billion by the end of 2022. That would give the stock a little less than a 20-fold revenue valuation.
But the problem is that revenue, although 47% higher than the year before, was only $ 470 million in the first quarter. This is an annual driving rate of $ 1.88 billion. And if you add a 15% increase for the fourth quarter, it’s an annual interest rate of almost $ 2 billion.
So the price and sales ratio for 2020 is now 41 times ($ 83 billion divided by $ 2 billion). To reach a 20 times higher price / sales ratio, revenue must grow 212% over three years to $ 4.15 billion. This means an annual growth ratio of 28.6%. It is a very high growth rate to assume for three years.
Is a higher growth rate possible?
Yes, the company could maintain such growth rates for the next three years. For example, the last quarter saw sales growth of approximately 9.5% over the past 12 months. And this has occurred in recent quarters, suggesting an annual growth rate of 43.5%.
In addition, Shopify reported that its underlying gross values (GMV) increased by 46% compared to the same period last year. This is very important because GMV is the basis for how Shopify generates revenue.
Here’s how it works: GMV is the value of goods and services purchased on Shopify’s platforms. Shopify receives a “tariff” or commission on GMV, which varies depending on the type of plan the seller has on its Shopify website. Take rate then generates revenue for Shopify.
So as GMV grows – through new third-party sellers and overall increased volume – net revenue at Shopify grows. The conclusion is that GMV growth looks very strong. It could possibly maintain an annual growth rate of 28-40% over the next three years.
Here’s a reason why I think GMV could maintain an annual growth rate of 28-40% for several years. Last quarter, Shopify reported that its GMV exchange rate for the whole of 2019 was $ 61.1 billion. If you annual Q1 GMV of $ 17.4 billion, the LTM driving speed of GMV is $ 69.6 billion. This corresponds to a growth rate of 13.9% in LTM GMV during Q1 compared to Q4. So a quarterly growth rate of 13.9%, even if not compounded, is 55.6%.
This shows me that the historical growth in GMV, and thus revenue, can easily average over 40% over the next three years.
Is the Shopify share worth its income several times?
I have shown that revenue on Shopify can easily double within the next three years. But does that mean that the Shopify share should be worth 42 times the revenue now?
This means that the valuation multiple will be 20 times the revenue at the end of 2023. The problem with this valuation is PayPal (NASDAQ: PYPL), another GMV-type company, which is worth only 9.3 times its LTM revenue. Its market value is $ 170 billion and LTM revenue was $ 18.26 billion. Amazon (NASDAQ: AMZN) also trades for only four times LTM revenue.
So the market can overestimate the high growth rate. Even the Cannacord analyst mentioned above said that a premium valuation 18 months ago would be 12 times revenue, not 20 times.
So even though I have no problem with the implied growth rate for today’s Shopify valuation, I think the multiple added to that growth rate is probably too high. In short, the stock is priced for perfection.
The latest capital increase confirms the premium valuation
One day after Shopify’s earnings report on May 6, the company announced that it would raise equity. This was not mentioned in the previous report.
The next day, Shopify had raised nearly $ 1.3 billion to $ 700 a share. Now Shopify had just reported a profit and also showed that it had $ 2.36 billion in cash on hand. In addition, this was only $ 100 million lower than cash at the end of the fourth quarter of 2019.
So what is happening? Shopify is very smart. You always collect cash when your shares have a premium valuation. You do the opposite – buy back shares – when it is below its fair value.
This is probably the best proof that Shopify is probably too high in terms of its valuation. The management knew this and decided to take advantage of it by raising unnecessary equity.
Therefore, I would wait for another, more appropriate time to buy Shopify shares. Even if it experiences solid growth rates, the multiple of that growth in its current valuation is too high.
At the time of writing, Mark Hake, CFA holds no position in any of the above securities. Mark Hake runs the Total Yield Value Guide, which you can review here.