Shopify is wildly overvalued, this investor says

It’s now over a year since Shopify (Shopify Stock Quote, Chart, News, Analysts, Financials TSX:SHOP) first lifted past Royal Bank as Canada’s largest company on the Toronto Stock Exchange, and talk seems to have died down a bit on whether SHOP has the staying power to keep that crown (so far, so good). So too have the comparisons with past tech flameouts like Nortel Networks and Research in Motion, again, at least for the time being.

But for portfolio manager John Zechner, Shopify’s resemblance to Nortel during the dot-com era is accurate at least in terms of SHOP’s now-dominant presence in the Canadian markets. Zechner says pair that with an inflated valuation and Shopify becomes an overly pricey stock that’s nonetheless difficult to avoid.

“I have certainly not been the voice of expertise on Shopify because I’m probably like a lot of other money managers —we just can’t bring ourselves around to the valuation,” said Zechner, chairman of J. Zechner Associates, who spoke on BNN Bloomberg on Thursday.

“The stock has continued to trade up but on the other hand they’ve delivered the growth and they continue to build up the platform, adding retailers en masse, expanding their offerings and just creating a super company in the process,” he said.

“But there’s a difference between a good or great company and a good stock, and I just see at these valuation levels … I mean, for $4 billion in annualized revenue right now you got a $170 to $180 billion market cap — it just seems really extended,” Zechner said. “You’ve got to deliver so much future growth in order to justify that valuation.”

Make no bones about it, Shopify has been consistent over the years in its ability to exceed expectations, a trait fully on display over the past year where the company’s success during a pandemic-impacted 12 months was monumental.

Want evidence? Shopify’s first quarter results earlier this year saw overall revenue jump 110 per cent year-over-year to just under a billion dollars at $988.6 million, while earnings climbed to $2.01 per share. Both numbers smashed through analysts’ estimates at $862.7 million and $0.75 per share respectively. The company’s balance sheet is looking good, too, with almost $8 billion in cash and equivalents.

Shopify gave a note of caution in its guidance with the Q1 report, saying 2021 more than likely won’t see the accelerated growth in e-commerce as did 2020, while management nonetheless kept up its confidence in SHOP’s platform and the onboarding of new merchants.

“Shopify’s momentum continued into 2021 as digital commerce tailwinds remained strong and merchants took advantage of the range of capabilities offered by our platform,” said Shopify CFO Amy Shapero in a press release. “We are focused on building a commerce operating system that will help shape the future of retail. Our merchant-first business model positions us to capture the massive opportunity presented by the growth of digital commerce, benefiting both our merchants and Shopify.”

And even though Shopify continues to sport a heady valuation (at about 400x forward earnings), believers see huge potential for growth where SHOP has still only captured a fraction of its global addressable market.

But Zechner is having nothing of it, at least for now.

“I’ve seen stocks get ahead of themselves and I’ve been wrong on this call, but still, you can’t drag me kicking and screaming to pay up to these kinds of levels at this point,” Zechner said.

“Now, the problem for a lot of money managers is when Shopify was a small part of the index [the valuation] didn’t matter,” he said. “Now that it’s the largest part of the index and it’s six or seven per cent weighting, on these days when Shopify has a strong move it’s very hard for us to beat the market because it’s the biggest part of the index. It’s almost like Nortel back in the mid-90s and late 90s. Nortel was so dominant in the index that, you know, don’t own it at your own risk.”

“So, I don’t own it in here. It’s a great company and I will keep my eye on it and maybe at a point we’ll change our minds but the valuation just is too much for me to handle in any sort of conservative, standard portfolio,” Zechner said.

Shopify finished the week up three per cent to $1,862.97, with the stock closing briefly mid-week above $1,900 for the first time. SHOP’s meteoric rise has been nothing short of remarkable, with the stock sitting at $200 as recently as early 2019.

Shopify’s market capitalization stands at $231 billion in comparison to Royal Bank at $180 billion. The total market cap of companies listed on both the TSX and TSX Venture Exchange is $3.3 trillion, which puts SHOP’s weighted percentage at about seven.