E-commerce enabler Shopify (SHOP -1.95%) surged at the pandemic onset as consumers shifted the majority of their spending online. Suddenly an online presence was vital for businesses while they were forced to shut their doors to in-person shoppers temporarily.
Now pandemic restrictions in many places have all but dropped, and folks are reducing online spending and visiting stores in person again. What's more, supply chain disruptions during the pandemic highlighted the limits of online shopping.
Regardless of which side of the fence you're on, it helps to consider the bull and bear cases on an investment.
Image source: Getty Images.
The bull case
Even before the onset of the pandemic, consumers were allocating more of their spending online. The convenience advantages over brick and mortar stores are several, including the fact that online stores are open 24/7, they ship to your doorstep, and they offer a more comprehensive selection, to name a few.
From the first quarter of 2010 to the first quarter of 2020 (before the outbreak), e-commerce sales as a portion of all retail sales increased from 4.2% to 11.5% in the U.S. That figure surged to 15.7% at the height of the pandemic before falling to 13% as of Q3 2021. And according to Statista, e-commerce spending will grow to $1.3 trillion in the U.S. in 2025, up from $767 billion in 2021.
Shopify's sales rose along with the growth in e-commerce spending. From 2012 to 2021, Shopify's revenue exploded from $24 million to $4.6 billion. If consumers are moving online, then businesses need to move online. Otherwise, they will lose sales to competitors.
Shopify helps entrepreneurs and even larger brands establish an online presence. It's no surprise, then, that its revenue has increased along with the growth of online spending. And perhaps more impressively, Shopify's revenue grew by 57% year over year in 2021 with the tailwinds from the pandemic receding.
And despite its rapid growth in the last decade, the company has room to go further. Management is working on several initiatives to keep the momentum going, including international expansion, supplying capital to client businesses, retail point of sale systems, and a fulfillment network. These excellent prospects may be why analysts expect Shopify to grow earnings per share at a compound annual rate of 38% over the next five years.
The bear argument
The bears likely concede that Shopify is a phenomenal growth stock. They will even grant that secular tailwinds, including e-commerce growth, are in its favor. But the bear argument centers around valuation. Shopify stock is not cheap. As of this writing, it is selling at price-to-sales (P/S) and price-to-free-cash-flow ratios of 17 and 178, respectively.
SHOP PS Ratio data by YCharts
Rival e-commerce platforms eBay and Amazon are trading at fraction of the price-to-sales ratios, at 3.4. Admittedly, Shopify is growing faster than the aforementioned and deserves a premium valuation. As mentioned earlier, Shopify is expected to grow earnings at a 38% rate over the next five years, while the same rates for eBay and Amazon are expected at 12.5% and 34.8% respectively.
But the bears will say a nearly 5X multiple is pushing it too far (see chart). The disparity has already been correcting itself, as Shopify's P/S ratio has fallen to 17 from a peak of over 60 reached several times in 2020 and 2021.
Shopify's stock is down 55% so far in 2022 as the bears have had the upper hand. However, it appears that the market has overcorrected. Shopify is now trading at the lowest P/S ratio in three years. What's more, it's selling at a lower price than it did before the outbreak. Since then, Shopify has signed up plenty of new customers who are unlikely to shut down their online businesses even after a pandemic.
