Stock splits are all the rage in today's market. They typically occur when a stock price reaches a level where many investors can no longer afford to purchase a whole share without overweighting a portfolio. While they have become less necessary now that fractional shares exist, many notable companies are splitting their stocks in the upcoming months.
Shopify (SHOP -2.37%) is one of those companies, but unlike Amazon and Alphabet (two other names that have or are planning to split their stock), it doesn't trade for more than $2,000. Instead, it's hovering around $375, meaning its planned 10-for-1 split will drop the stock to a mere $37.50 per share. Shareholders approved the stock split during its annual meeting. So with the stock split approved, does this make Shopify a buy?
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No respect for the company's pandemic-era growth
Shopify's software allows its users to create and manage an e-commerce store. Regardless of a customer's size, the company has tools to fit every need like credit card processing, inventory management, and shipping solutions.
Its stock soared during the pandemic as it brought on tons of new users. However, with the love of e-commerce stocks now fading, the stock trades below its pre-pandemic price, down nearly 80% from its all-time high, despite its gross merchandise volume (GMV) rising 69% annually over the past two years.
Why is the market so bearish about a company that has been consistently exceptional? It all boils down to two reasons: competition and market penetration.
A potential growth killer
The most recent concern with Shopify is Amazon (AMZN -1.65%) introducing its "Buy with Prime" service. This add-on allows businesses to sell their products through their e-commerce site, but customers can check out with one button using Amazon Prime. Amazon then processes the transaction and delivers the package with the speed you'd expect from the world's largest e-commerce company.
You'd think Shopify would be concerned about this, but apparently, it's excited about it. In Shopify's first-quarter investor call, CEO Tobi Lütke said he was "thrilled" about Amazon offering this to small businesses, and the company would work to integrate this feature into Shopify stores.
While Lütke may not be concerned, should investors be? After all, Amazon would likely keep some of the transaction processing fees, cutting into Shopify's revenue. This revenue stream is a big deal for Shopify, as its merchant solutions division (which makes money by taking a slice of transactions processed through Shopify stores) made up 72% of its first-quarter revenue.
Image source: Getty Images.
I think investors should rest easy, though, as Shopify will likely strike a deal with Amazon to share the transaction revenue. Additionally, the Buy with Prime button will likely increase buyer confidence, which can lead to higher conversion rates. Finally, many companies already partner with Shopify. To scrap all of the integration and familiarity with Shopify's system isn't a simple task. All in all, it's a net neutral for Shopify, and investors should spend their time examining the rest of the business.
Another concern for Shopify is market penetration. Most businesses established an online presence when forced to close their doors during the pandemic. Therefore, anyone starting a Shopify store is likely a new shop, not an existing customer with solid sales.
This market penetration means rapid growth could be harder to come by. However, Shopify's revenue grew 22% year over year in its most recent quarter with GMV rising 16%. While this may seem like solid growth already, management expects it to accelerate in the second half of the year and reach its peak during the fourth quarter.
One thing to keep in mind is when management gave this guidance: May 5. Since then, Walmart and Target have raised concerns about weakening strength among American consumers. So until Shopify can give updated guidance, investors will need to trust management or steer clear of the stock.
Is Shopify a buy or sell?
I believe the stock is a great value right now. Assessing Shopify from a three-to-five-year standpoint, I can discount the consumer issue. Unless the economy takes an extended slide, Shopify's customer cohorts should be back on track in that time frame. Additionally, as e-commerce grows, Shopify will bring in more transaction revenue, even if it has to share some with Amazon.
Wall Street analysts seem to agree -- the consensus "buy" recommendation with an average price target of $612.86 represents 64% upside from the current price. With the stock trading at a price-to-sales ratio of 10 (the lowest it has reached in the last five years), it's also much cheaper from a valuation standpoint.
If Shopify reports strong second-quarter numbers, expect shares to soar, because there's a lot of negativity baked into the stock. If you're willing to hold it long term, you allow Shopify's most attractive elements to shine, giving the stock a better chance to produce outsized returns.
