Investors looking at where to put their money can benefit by identifying key factors at a company, including visionary leadership, a track record of strong performance, and a business at the center of a secular growth trend. Amazon (AMZN -1.64%) and Shopify (SHOP -2.37%) check those boxes and more.
Amazon has a visionary founder leader in Jeff Bezos and has grown into a $1.6 trillion (by market cap) retailing juggernaut. Shopify is lesser-known but has shown Amazon-like growth under its visionary founder leader, Tobi Lutke, since a 2015 public offering. It helps merchants set up digital stores and then provides services to help those businesses grow.
E-commerce has been expanding for years, but it took off when the coronavirus pandemic led to stay-at-home orders. Shopify shares are up about 130% this year. Amazon is up about 70%. Which is the better buy right now? Let's take a look.
Image source: Getty Images.
A look at Shopify
Shopify sells subscriptions primarily to small- and medium-sized businesses to set up and operate an online store for as low as $29 per month. It also sells Shopify Plus, starting at $2,000 a month, for larger businesses. The company has grown its merchant base quickly, and last year it passed 1 million users on the platform, producing a growing source of monthly recurring revenue.
In March, as businesses scrambled to launch online stores as stay-at-home orders were put in place, Shopify temporarily extended its free trial from 14 days to 90 days. That helped produce a 71% increase in new stores from the first quarter to the second quarter of 2020. The company later said new stores created during the extended free trial were converting at a "slightly lower" rate than merchants who joined before the pandemic. The company also noted that some merchants' free-trial period extended into the third quarter, and conversions of those merchants into paying customers would benefit revenue in that period.
Once Shopify lands merchants, it sells them various services, ranging from marketing to shipping to short-term loans for working capital. Shopify Payments, a payment processing service, is a good example of how the company's growth is aligned with its merchants' success.
Shopify charges a small transaction fee for each payment. That means if its merchants are selling more, Shopify benefits. Its second-quarter payments growth was staggering and fueled a huge surge in overall revenue. Total sales on Shopify's platform, known as gross merchandise volume, were $30.1 billion, a 119% increase from a year earlier. Shopify's cut from its payment processing service was $13.4 billion, up 131%. Total revenue skyrocketed 97% from the previous year.
Lutke, a co-founder of the company launched in 2006, remains Shopify's CEO. He has kept the company innovating and growing. Recent growth initiatives include the Shop app, a mobile platform to connect shoppers with local Shopify businesses. The company also announced a partnership with Walmart to get more Shopify merchants on the retail giant's platform. In June 2019, Shopify launched its fulfillment network, a service that lets merchants store inventory at distribution centers, where workers pick, pack, and send deliveries.
An online sales app, a fulfillment network, and visionary leadership? Sounds like a familiar growth strategy.
The chart below shows the recent growth of a $10,000 investment in both Shopify and Amazon.
A look at Amazon
Amazon's revenue in 2019 was $281 billion, and about 87% came as a result of online sales. But what's most impressive about Amazon is not growing retail sales. It's Bezos' ability to continually keep an enormous company evolving and growing in new areas.
One of those is digital advertising, the company's "other" segment that produced $8.1 billion in the first six months of 2020. That's up 42% from the previous year, and it's becoming a more meaningful part of the company's overall revenue. Additionally, Amazon Web Services (AWS) is the market leader in cloud computing. The division produced $21 billion in the first six months of the year, up 31% year over year. AWS accounts for about two-thirds of Amazon's operating profit.
Amazon's net sales were up 40% year over year in the second quarter, remarkable growth for a company its size. It produced $31.9 billion in free cash flow in the trailing 12 months, which can be used to invest in future growth. That includes a push into groceries, where Amazon is taking on market leader Walmart. While groceries are a low-margin business, the market is massive. Walmart's grocery revenue was $190.6 billion last year.
Valuation and my final call
Amazon's and Shopify's stocks are always highly valued. After all, good companies are rarely cheap. However, their price-to-sales ratios have gone especially high in recent months.
|
Company |
P/S Ratio |
P/S Ratio, |
Percent Above 5-Year Avg. |
|---|---|---|---|
|
Amazon |
4.9 |
3.4 |
44% |
|
Shopify |
52.5 |
18.5 |
183% |
Data source: YCharts.
While Shopify's P/S ratio is more than 10 times higher than Amazon's, that's somewhat understandable. Shopify is a smaller, faster-growing company. That usually means a higher valuation, because smaller companies are often expanding into new markets, the same way larger companies did in their early years. That expansion can fuel fast revenue growth, and investors are willing to pay higher premiums for higher growth.
What's important to note is that Shopify's P/S ratio is nearly triple its five-year average. Amazon's P/S ratio had also soared to its highest level in more than 10 years until a recent pullback. The P/S ratio shows how much Wall Street values a dollar of sales. In Shopify's case, one dollar of revenue is being valued at $52.50 in the stock price. That compares to the company's five-year average of $18.50. In short, its stock price moved up much faster than its sales. So did Amazon's, but the increase in valuation is not necessarily surprising.
E-commerce has been growing for years, and COVID-19 accelerated the move to online shopping. I believe both companies' prospects are strong, and buying at these prices will pay off over the long term (3-5 years and beyond). However, there could be some bumps in the short term if either of the high-flying growth companies falls short of the high expectations priced into their stocks. That kind of pullback could be a buying opportunity.
If I was buying only one today, it would be Amazon. I think Shopify has the stronger growth prospects, but its valuation has gone into nosebleed territory. I believe Amazon's lower valuation and the diversified revenue stream that AWS provides make it a lower risk and the better buy right now.
