Shopify's (SHOP 2.58%) software and services help people and businesses sell things online. When businesses were forced to embrace e-commerce in the early days of the pandemic, Shopify was the path of least resistance and quickly became the default choice.
Revenue soared 86% for Shopify in 2020, and that momentum continued throughout much of 2021. The stock followed suit until recently. Between the start of 2020 and mid-November 2021, Shopify stock more than quadrupled.
Revenue growth was part of the equation, but so was multiple expansion. Shopify was a pricey stock before the pandemic, trading around 30 times annual sales. At its peak, Shopify was trading hands at 60 times annual sales.
Shares of Shopify have been tumbling since late last year, and the company's fourth-quarter report on Wednesday triggered a massive sell-off. Shopify's price-to-sales ratio is now around 22. The premium that investors awarded Shopify stock for its pandemic-era performance is completely gone.
No more pandemic tailwinds
If you paid 60 times sales for Shopify, you really had to believe that growth wouldn't slow down all that much once the pandemic was over. You also probably needed to believe that earnings would continue their march upwards. Shopify became decently profitable during the pandemic as businesses flocked to the platform after years of posting losses.
Shopify's outlook for 2022 makes it clear that both revenue growth and profits are going to come under pressure as the tailwinds of the pandemic disappear. Shopify kept things vague, but it expects revenue growth in 2022 to come in below the 57% growth it reported for 2021.
The company did say it expects to outpace the growth of the e-commerce market, but that's not a very high bar. U.S. e-commerce sales are estimated to have grown by just over 14% last year, and there's little reason for 2022 to be dramatically better.
Profits will likely take a hit for multiple reasons. First, Shopify expects merchant solutions to grow at more than twice the rate of subscription solutions. Subscription solutions growth, which is tied to growth in the customer count, was just 26% in the fourth quarter of 2021. Subscriptions produced a gross margin of around 80% in 2021, so a slowdown in this segment is bad news for the bottom line.
The merchant solutions segment includes things like payments and shipping services. Gross margin in this segment was just 43% last year, so a mix shift toward merchant solutions is going to knock down Shopify's overall gross margin.
On top of the gross margin headwind, Shopify plans to hurl all its gross profit back into the business. The company plans to ramp up the hiring of research and development engineers this year despite a competitive labor market, and hiring for sales and marketing positions will accelerate as well. Shopify is going on a spending binge, hoping that various new services and initiatives lead to faster growth in the long run.
Is Shopify a buy?
There's no question that Shopify has become a dominant force in the e-commerce market. But price matters. Shopify at 60 times sales is an entirely different investment compared to Shopify at 20 times sales. And Shopify at 20 times sales is an entirely different investment compared to Shopify at, say, 10 times sales.
If Shopify can only muster annual revenue growth between 20% and 30% for the foreseeable future, and if profits plunge as hiring ramps up, is paying 20 times sales reasonable? In a world where inflation is running hot and even the most boring companies can post solid growth due to higher prices, probably not. At least, not to me.
Maybe the investments Shopify is making will boost growth later this year. If they don't, it's not hard to imagine Shopify stock tumbling further before hitting bottom.