Shopify Stock Is Skyrocketing - Is It Too Hot to Handle?

One of today's standouts was Shopify, a software company whose shares are up 7.6%, outperforming the Nasdaq by 7.8%. At $39.57, the stock is not far from its average analyst target price of $40.65. The average analyst rating for the stock is buy. SHOP may have outstripped the S&P 500 index by 8.1% today, but it has lagged behind the index by -63.0% over the last year, returning -76.5%.

Shopify Inc., a commerce company, provides a commerce platform and services in Canada, the United States, Europe, the Middle East, Africa, the Asia Pacific, and Latin America. The companyis in the technology sector, which groups together a wide range of industries including consumer electronics, software, computer hardware, scientific instruments and IT services. Legendary investor Warren Buffet once stated that he would never invest in technology companies. Apple is now one of his largest holdings.

The risks inherent to the technology sector are clear, but investors simply cannot ignore the potential for strong returns. Even with the lessons learnt in the 2000 tech bubble, the market continues to highly value the promise of technological innovation and the ability for these companies to build and occupy new markets.

Shopify's trailing 12 month P/E ratio is 304.4, based on its trailing Eps of $0.13. The company has a forward P/E ratio of 989.2 according to its forward Eps of $0.04 -- which is an estimate of what its earnings will look like in the next quarter. As of the third quarter of 2022, the average Price to Earnings (P/E) ratio of US technology companies is 26.5, and the S&P 500 average is 15.97. The P/E ratio consists in the stock's share price divided by its earnings per share (Eps), representing how much investors are willing to spend for each dollar of the company's earnings. Earnings are the company's revenues minus the cost of goods sold, overhead, and taxes.

Shopify's P/E ratio tells us how much investors are willing to pay for each dollar of the company's earnings. The problem with this metric is that it doesn't take into account the expected growth in earnings of the stock. Sometimes elevated P/E ratios can be justified by equally elevated growth expectations.

We can solve this inconsistency by dividing the company's trailing P/E ratio by its five year earnings growth estimate, which in this case gives us a 16.63 Price to Earnings Growth (PEG) ratio. Since the PEG ratio is greater than 1, the company's lofty valuation is not completely justified by its growth levels.

To better understand the strength of Shopify's business, we can analyse its operating margins, which are its revenues minus its operating costs. Consistently strong margins backed by a positive trend can signal that a company is on track to deliver returns for its shareholders. Here's the operating margin statistics for the last four years:

Date Reported Total Revenue ($) Operating Expenses ($) Operating Margins (%) YoY Growth (%)
2021-12-31 4,611,856,000.0 4,231,351,000.0 8.25 39.12
2020-12-31 2,929,491,000.0 2,755,866,000.0 5.93 180.68
2019-12-31 1,578,173,000.0 1,694,151,000.0 -7.35 14.14
2018-12-31 1,073,229,000.0 1,165,149,000.0 -8.56 n/a
  • Average operating margins: -0.4 %
  • Average operating margins growth rate: 78.0 %
  • Coefficient of variability (lower numbers indicate less volatility): 2023.5 %

Shopify's financial viability can also be assessed through a review of its free cash flow trends. Free cash flow refers to its operating cash flows minues its capital expenditures, which are expenses related to the maintenance of fixed assets such as land, infrastructure, and equipment. Over the last four years, the trends have been as follows:

Date Reported Cash Flow from Operations ($) Capital expenditures ($) Free Cash Flow ($) YoY Growth (%)
2021-12-31 504,428,000.0 -50,788,000.0 453,640,000.0 18.37
2020-12-31 424,958,000.0 -41,733,000.0 383,225,000.0 2665.77
2019-12-31 70,615,000.0 -56,759,000.0 13,856,000.0 174.39
2018-12-31 9,324,000.0 -27,950,000.0 -18,626,000.0 n/a
  • Average free cash flow: $208,023,750.00
  • Average free cash flow growth rate: 952.8 %
  • Coefficient of variability (lower numbers indicating more stability): 117.8 %

Free cash flows represents the amount of money that is available for reinvesting in the business, or paying out to investors in the form of a dividend. With a positive cash flow as of the last fiscal year, SHOP is in a position to do either -- which can encourage more investors to place their capital in the company.

Another valuation metric for analyzing a stock is its Price to Book (P/B) Ratio, which consists in its share price divided by its book value per share. The book value refers to the present liquidation value of the company, as if it sold all of its assets and paid off all debts. As of the third quarter of 2022, the average P/B ratio for technology companies is 5.57. In contrast, the average P/B ratio of the S&P 500 is 2.95. Shopify's P/B ratio indicates that the market value of the company exceeds its book value by a factor of 5.8, so it's likely that equity investors are over-valuing the company's assets.

As of third quarter of 2022, Shopify is likely fairly valued because it has an inflated P/E ratio, an average P/B ratio, and a pattern of improving cash flows that are on an upwards course. The stock has poor growth indicators because of its negative operating margins with high variability with a stable trend, and an inflated PEG ratio. We hope this analysis will inspire you to do your own research into SHOP's fundamental values -- especially their trends over time.

The above analysis is intended for educational purposes only and was performed on the basis of publicly available data. It is not to be construed as a recommendation to buy or sell any security. Any buy, sell, or other recommendations mentioned in the article are direct quotations of consensus recommendations from the analysts covering the stock, and do not represent the opinions of Market Inference or its writers. Past performance, accounting data, and inferences about market position and corporate valuation are not reliable indicators of future price movements. Market Inference does not provide financial advice. Investors should conduct their own review and analysis of any company of interest before making an investment decision.