Is Shopify a Buy?

While small and medium-sized businesses (SMBs) have difficulty competing against commerce powerhouses like Amazon and Walmart, companies like Shopify (SHOP 4.90%) have been helping them compete. After the pandemic began in 2020, Shopify saw a huge boom as every business -- big and small -- rushed to establish an online presence.

Now that this wave is over, Shopify's business model has switched. This shake-up caused a lot of investors to bail, and the stock is now down about 70% from its all-time high. However, Shopify's stock is turning around rapidly in 2023 and is already up 45% year to date.

Have investors missed the move on this one? Or is there still room to run? Let's find out.

Shopify's price hike will help its profitability, but it's still not enough

Shopify provides the e-commerce tools that SMBs need to compete against anyone online -- credit card processing, an online store, and point-of-sale tablets for an in-person presence. Until recently, the price for these plans remained unchanged for about 12 years. However, Shopify recently announced price increases to its plans.

Data source: Shopify.

Shopify Plus, its premier service reserved for its biggest commerce customers, remained unchanged, with its $2,000-per-month base price tag. Still, this isn't going to move the needle that much for Shopify as it brought in about $107 million in monthly recurring revenue (MRR) in Q3, compared to $990 million from merchant solutions (the slice of each transaction that Shopify takes from stores on its platform) and $269 million from other subscriptions.

Of its MRR, $35 million comes from Shopify Plus, indicating about $72 million will be affected by this 33% price increase. However, the $24 million it will generate from the price increases will be pure profit, something Shopify desperately needs. In Q3, Shopify lost $345 million from its operations, so the $24 million is a drop in the bucket.

However, investors should start to see some improvements in this figure from the layoffs that Shopify initiated in July 2022, letting go about 10% of the company. At the time, these layoffs spooked investors as few other companies were making this hard choice. Now, tech layoffs have become almost expected, showing that management had both the foresight and boldness to make the hard choices -- something investors should applaud and look for in a company.

But Shopify still has a ways to go before investors see profits.

Some items to watch for in Q4

Q3 saw operating expenses rise 64% over last year, helping to drop its operating loss margin from 0.4% in 2021 to a 25% loss this year. The layoffs won't reverse this trend, but they certainly will help. Compared to revenue rising 22%, Shopify will need to generate more growth or continue its pattern of cost-cutting. Investors must watch these two items when Shopify reports earnings on Feb. 15.

So why has the stock run up so much in 2023?

The answer has to do with sentiment change. With about 73% of Shopify's revenue coming from merchant solutions in Q3, the more consumers spend on its clients' stores, the more money Shopify makes. Now that recession fears have quelled, optimism has returned to many stocks, including those with a heartbeat on discretionary spending, including Shopify.

Additionally, Shopify entered 2023 at its lowest price-to-sales valuation ever.

SHOP PS Ratio data by YCharts

Will Shopify return to its lofty 50 times sales valuation levels of 2021? I'd say no, and you should avoid the stock if it does. But, its 12 times sales is still below where it traded from 2017 to 2019, possibly making investors think it's slightly undervalued. 

However, that was before Shopify had a massive business boost in 2020 and 2021. With that catalyst gone, the growth trajectory for Shopify has significantly changed. Anchoring to those previous valuations is a dangerous trap and can lose investors money.

The investment thesis of Shopify has changed from customer growth to product expansion, which isn't a bad thing -- it's just different. Therefore, investors should be patient to see what Shopify has to say during its Q4 earnings report; that way, you can hear the outlook for 2023.

The rapid price movement might have been overdone, so investors should exercise caution with Shopify's stock right now.