Shopify stock (NYSE:SHOP) has rallied by about 66% over the past year, reflecting the company’s ongoing success in sustaining excellent growth metrics. The leading platform for building e-shops has been driving strong GMV, revenues, and free cash flow growth, boosting investor confidence in the stock. Yet, Shopify’s extended rally reminds me of the ever-present concern surrounding the stock — its valuation. Importantly, the premium attached to Shopify stock offers no margin of safety. Thus, I am neutral on the stock.
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Excellent Growth Across the Board
Let me start with the positive part of Shopify’s investment case, which primarily includes the company managing to sustain excellent growth across the board. I find this to be a very impressive achievement, given both the tough comps from previous years and the added headwind caused by the Federal Reserve’s efforts to cool down the economy.
Regarding the tough comps from previous years, note that Shopify posted revenue growth of 26.1% in FY2023, marking an acceleration from FY 2022’s 21.4%. In the meantime, these numbers follow a 57.4% increase recorded in FY 2021 and the 85.6% growth achieved in FY 2020. The fact that Shopify continues to grow at such a strong growth pace even after the pandemic-induced explosive surge is truly remarkable.
As far as the Federal Reserve’s efforts to slow down the economy go, one would expect that rising interest rates would pressure consumer spending. That should directly translate to pressure on Shopify’s revenues, as its merchants would also face difficulties. On the contrary, the economy was proven highly resilient last year, resulting in growing consumer spending. Thus, Shopify faced no issues in continuing to thrive.
A look at Shopify’s most recent Q4 report shows the growth in consumer spending driving gross merchandise volumes (GMV) and Shopify Payments-tied GMV. In turn, these catalysts contributed to strong revenue growth. In particular, GMV in Q4 was $75.1 billion, up 23% year-over-year. This was the most significant quarterly GMV growth rate since the pandemic-induced growth rates of 2021.
Besides consumer spending staying robust, which resulted in higher same-store sales, management noted that GMV growth came from multiple areas. It was powered by Shopify’s merchant base expanding globally, the 40% growth recorded in Europe, the Middle East, and Africa, and notable growth in offline sales. In particular, offline GMV rose by 28% in Q4.
The notable growth in GMV, combined with more merchants opting for Shopify Payments as their main payment processor for seamless operations, also contributed to total revenue growth. Shopify Payments penetration reached 60% among merchants by Q4, up from 56% the previous year, boosting Payments-related GMV by 45%. With the platform typically charging 2.9% + 30¢ for each such transaction, Shopify Payments further fueled Q4 revenue growth, which grew by 24% to $2.1 billion for the period.
It’s also worth noting that revenue growth would have been 30% if Shopfiy’s logistics business had been included in the results, but that was sold to Flexport last year. In this context, the company’s revenue growth acceleration becomes even more impressive.
Free Cash Flow Surges, But Proceed with Caution
Shopify’s robust revenue growth and efforts to control spending resulted in free cash flow surging in Q4 and FY 2023 as a whole. Yet, I would proceed with caution regarding Shopify’s free cash flow numbers. Let me explain why.
To begin with, besides the growth in revenue, which allows Shopify to scale the business’s margins over time, the company managed to improve its profitability by controlling its expenses. For example, R&D costs fell from $440 million last year to $311 million in Q4. Therefore, Shopify’s Q4 free cash flow margin more than quadrupled, reaching 21%, up from 5% in Q4 2022. Consequently, for the quarter, free cash flow surged to a record $446 million or a record $905 million for the year.
Nevertheless, I would urge investors to be cautious with these numbers, particularly due to Shopify’s rich stock-based compensation. To explain, the annual figure of $905 million includes $615 million in SBC. This is a very real expense due to its dilutive nature, even though many investors tend to ignore it. See below.
Valuation Concerns Remain, Strong Free Cash Flow Estimates
Wall Street expects Shopify’s free cash flow growth momentum to persist. That said, I still think that the valuation concerns will continue to surround the stock. A look at the numbers makes this self-explanatory.
Consensus estimates forecast Shopify to achieve $1.19 billion and $1.67 billion in free cash flow in FY 2024 and FY 2025, respectively. However, this implies that the stock is currently trading at 81 times and 58 times this and next year’s anticipated free cash flow, respectively. From a P/E perspective, Shopify trades at about 73 and 56 times this and next year’s expected earnings, respectively.
These are incredibly high multiples, no matter your future expectations about Shopify’s earnings and free cash flow growth. But even if Shopify’s future growth can somehow justify paying this much, there is little to no margin of safety for current investors if Shopify were to fall short of Wall Street’s estimates.
Is SHOP Stock a Buy, According to Analysts?
Despite SHOP’s notable rally, Wall Street remains bullish on the stock. The stock features a Moderate Buy consensus rating based on 12 Buys, 14 Holds, and three Sells assigned in the past three months. At $82.84, the average Shopify stock price target implies 15.1% upside potential.
If you’re wondering which analyst you should follow if you want to buy and sell SHOP stock, the most profitable analyst covering the stock (on a one-year timeframe) is Richard Tse of National Bank (TSE:NA), with an average return of 86.28% per rating and an 81% success rate. Click on the image below to learn more.
The Takeaway
To sum up, while Shopify’s GMV expansion and revenue growth remain impressive in the face of tough comps and a hawkish Fed policy, valuation concerns loom large. Sure, free cash flow growth expectations may seem promising, but even under these assumptions, the stock seems to be trading at extremely high multiples. This raises caution flags, in my view, which is why I choose to stay on the sidelines on this one.
