Individual shares of Shopify (SHOP -2.37%) are about to be much more affordable. The company is on the verge of its highly publicized 10-for-1 stock split and shares will begin trading on a split-adjusted basis when the market opens on Wednesday, June 29.
On the eve of its stock split, investors who didn't want to shell out nearly $400 per share may now be willing to give the company a second look.
With that as a backdrop, is Shopify stock a buy after its stock split?
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Stock Splits 101
While stock splits may tend to drum up a lot of interest in companies engaging in them, it's important to remember the basics of a stock split. While investors will end up with 10 Shopify shares for every one they own pre-split, each share will be worth 10% of its previous price, so the economic value won't change. Therefore, investors shouldn't buy Shopify stock after the split merely because the shares are "cheaper," or because they believe the stock might suddenly have more upside than it had before.
To fully appreciate how Shopify's split will play out, imagine shares of the e-commerce platform are trading at $400 just prior to the stock split. For an investor that owned five shares, the value of their Shopify holdings would be $2,000. After the split is completed, that same investor would own 50 shares worth $40 each, since each original share will be divided by 10. In fact, it's much like owning 10 dimes instead of a dollar bill. The economic value is still exactly the same.
Investor psychology versus business performance
While investors may well understand the mechanics of a stock split, there's a common misconception that the lower stock price will ultimately drive the stock higher, as investors flock to the newly cheaper shares. For example, some may believe that it will be easier for Shopify to achieve 20% gains over the coming years as a $40 stock than it could if it were a $400 stock.
There's simply no historical evidence to support this assertion, and while investor psychology can fuel stock price gains over the short term, it's ultimately the company's business performance that will drive the stock over the longer term. Even if the share price were to be buoyed for several months due to investor enthusiasm for the lower split-adjusted stock price, that euphoria could be quickly overtaken by news -- good or bad -- regarding the company's business performance.
The takeaway is that investors should remain focused on the direction of Shopify's underlying business, not the largely symbolic gesture of a stock split.
Is Shopify stock a buy?
A look under the hood shows that while Shopify stock has hit a temporary slump, the business still has plenty of room to run. In fact, Shopify has gained 1,350% since its IPO in mid-2015, even after the stock's recent bear market-induced decline.
Some investors have been spooked by Shopify's rapidly decelerating growth, but that requires context. In the first quarter, revenue grew 22% year over year, but that was stacked on top of 110% growth in the prior-year quarter, resulting in historically difficult comps. Gross merchandise volume (GMV) -- which represents the value of goods sold on the platform -- faced similar headwinds, up 16% on top of 114% growth during the year-ago quarter. Over the next few quarters, as comps begin to normalize, Shopify's growth should be closer to historical averages.
The recent tech-centric bear market has punished stocks with frothy valuations. Shopify certainly wasn't immune, as its stock has slumped more than 75% since its November highs. That, in turn, has pushed its price-to-sales (P/S) ratio below 10, marking its lowest valuation in more than five years. Looking out a year, the valuation is even more enticing, with a forward P/S ratio of about 6.
While the growth of e-commerce has temporarily slowed in the wake of accelerated adoption during the pandemic, don't for a minute think that's the end. Global digital sales topped $4.9 trillion in 2021 and are expected to surge to nearly $7.4 trillion by 2025. As the industry-leading e-commerce platform for entrepreneurs, merchants, and enterprises alike, Shopify is well positioned to continue riding this secular tailwind.
In view of Shopify's industry leadership, historically low valuation, and large and growing addressable market, investors shouldn't hesitate to add Shopify shares in the wake of its stock split.
