Shopify (Shopify Stock Quote, Chart, News, Analysts, Financials TSX:SHOP) shares have gotten hammered with the recent pullback on tech stocks, which means investors now have a window to pick up the stock well below its all-time highs. But take another look at SHOP before you buy, says portfolio manager Michael Sprung, who points to the skewed fundamentals as reason to be cautious.
“We’re value investors and so when things hit multiples that have P/E’s as high as Shopify’s we try to look at how long it would take for those earnings to catch up to the price,” says Sprung, president of Sprung Investment Management, speaking on BNN Bloomberg on Tuesday.
Shopify had a nice bounce back on Tuesday, rising more than four per cent and recouping some of its losses of late. The stock about flat for the year now, after posting solid gains through January and early February. But the general move away from tech stocks has impacted Canada’s e-commerce juggernaut, which finished 2020 up a monster 178 per cent.
As with a number of tech names like Apple and Microsoft, Shopify did well during the COVID-19 pandemic with its customers, businesses who had to seriously up their online game in order to make it through government imposed shutdowns. Shopify saw a huge boost in traffic on its platform starting early last year as businesses small and large turned to e-commerce to get them through the pandemic and beyond.
“The spirit of entrepreneurship was strong in 2020, as our merchants’ resilience and ability to adapt helped many of them thrive in a difficult year,” said Harley Finkelstein, Shopify’s President, in the company’s fourth quarter and full-year 2020 press release last month.
“Shopify is at the heart of our merchants’ businesses with entrepreneurs around the world trusting us with their livelihoods. This year, we are doubling down on creating a frictionless path to successful entrepreneurship, as we continue to build a future-proof commerce solution to serve generations to come,” Finkelstein said.
The numbers bore it out, too, as Shopify saw revenue grow by 94 per cent year-over-year for the fourth quarter, while adjusted net income was $198.8 million or $1.58 per diluted share compared to $50.0 million or $0.43 per share a year earlier. For the 2020 year, SHOP’s revenue was up 86 per cent to $2.930 billion and adjusted net income hit $491.3 million or $3.98 per diluted share. (All figures in US dollars except where noted otherwise.)
The company seems to have a lot of growth ahead of it, as well, as SHOP keeps expanding internationally, with its fulfillment network continues its build-out and assets like Shop App and Shopify POS look to be just getting started. Thus, even though 2020 may have been a bit of an anomaly in terms of growth — and Shopify management said as much in their 2021 outlook delivered in the Q4 earnings — the runway still looks long and wide.
Shopify may be dressed for success but the stock’s valuation should tell investors a different story, according to Sprung.
“I look at Shopify today and it’s trading somewhere in the neighbourhood of $1,395. It does have positive earnings which is a good thing but the P/E is still around 420x,” Sprung said. “Now, when you think about it, when you pay 420x earnings, if you bought a stock that earned one dollar and it had no growth, it would take 420 years before those earnings added up to what you paid for it, let alone discounting that back.”
“But even if you take Shopify and say that you that it could grow earnings, say, even at 20 per cent a year, it would still take 25 years for that sum to to come to fruition,” he said.
“And by then, even if you said the multiple was normalized you’d still get a price of about $6,300 on the stock and after 25 years that would be about a six per cent return on your investment, assuming no dividends,” Sprung said.
“So, I think that’s a little bit risky from a value investor’s point of view. I could certainly see it for growth investors who are willing to pay for growth but for me to think that a company is going to be able to grow earnings at 20 per cent a year over a 25-year period, that’s a little bit much, and it’s not where I would be looking,” Sprung said.
Shopify took advantage of its ballooning share price when last month it closed on a public offering of 1.18 million shares, generating for the company a whopping $1.551 billion in gross proceeds. Shopify said that it plans to use the funds to strengthen its balance sheet and to provide flexibility to execute on its growth strategies.