Investors drove the stock of Shopify (SHOP -1.26%) up 54% from the beginning of the year to Feb. 15, when the company released its earnings results for the fourth quarter of 2022. Clearly, investors expected a lot from the report.
The company beat analysts' revenue and earnings-per-share (EPS) estimates for the fourth quarter. But investors were disappointed in the first-quarter forecast, which anticipates slowing revenue growth. The stock sank about 16% the day after the earnings release.
So, should you buy the dip on Shopify's stock as did Cathie Wood's Ark Invest, which bought it heavily after the dive, or should you give this richly valued stock a pass?
As COVID-19 vaccinations became more prevalent throughout 2021, the economy began opening back up, and the conditions that significantly boosted Shopify in 2020 receded. With a drop in online shopping demand, high inflation, and rising interest rates, Shopify's revenue acceleration quickly slowed. After Shopify's revenue growth peaked at 110% in the first quarter of 2021, it was all downhill from there.
SHOP Revenue (Quarterly YoY Growth) Data source: YCharts
With revenue growth tumbling, the high level of operating expenses taken on during the pandemic proved to be too much for the company to turn a profit. As shareholders realized the company could not make money or reach positive free cash flow (FCF), they sold the stock. Nothing is worse than a growth stock with slowing revenue growth, a lack of profits, and negative FCF in a high-inflation, rising-interest-rate environment.
The company can move toward profitability by spending less, and its first step was taking a tactical retreat by laying off 1,000 workers in July 2021. However, cutting costs to achieve profitability is easier said than done. For instance, Shopify needs to continue building out its Shopify Fulfillment Network (SFN) to remain competitive against Amazon, and to retain its critical workers in a competitive market for talent, the company needed to adjust its compensation structure, which raises costs.
Image source: Shopify
You can expect these headwinds to profitability throughout the first three quarters of 2023. The market likely won't respond favorably to the company reporting sluggish progress in bringing down expenses, especially should inflation reignite or if there is a recession.
There's a lot to like long-term
Retailers desperately want a platform to sell their wares other than Amazon, which has challenged its third-party retailers in the past by competing against them and providing unfavorable terms for being a vendor on its platform. Shopify has already proven to be that platform for many third-party retailers of all sizes, having captured 10% of the U.S. e-commerce market in 2022 and over $500 billion in global commerce since its inception in 2006.
To separate itself from similar e-commerce platforms like BigCommerce and website-building software like WordPress, Shopify is building a last-mile fulfillment network to compete against Fulfillment by Amazon.
In July 2022, it purchased Deliverr to integrate into SFN to establish a complete end-to-end "port to porch" logistics platform. So far, the acquisition has proven successful. For example, on its fourth-quarter 2022 earnings call Chief Executive Officer Tobias Lütke said, "Compared to Q4 of 2021, we've seen a 40% increase in orders per merchant, while Deliverr has achieved over 50% growth in units fulfilled and more than doubled its services outside of fulfillment, services like freight, B2B, parcels and returns."
One of the main reasons that Ark Invest is buying the pullback in Shopify's stock is that should SFN continue to gain traction with retailers, the company has a solid growth runway for the next 10 years.
Should you buy the stock?
The market values the stock at a price-to-sales ratio of 9.2, which is much higher than its peers.
SHOP PS Ratio Data source: YCharts
Although the company has a high upside over the long term, it also has high execution risk in the current environment. Should the company fail to execute and underperform analysts' high revenue and earnings expectations, which is a strong possibility in a climate where economists are still debating whether the economy will go into recession, the stock could drop significantly from its current lofty P/S ratio.
Another factor to consider is that SFN will require significant investment over many years to compete against Amazon's and Walmart's substantial logistics operations, which are also improving rapidly. As a result, there is no guarantee that it will succeed in fulfillment in the long term.
If you are a cautious investor in today's gloomy economic environment, there are alternative investments with a similar high long-term upside as Shopify that are less risky.
