Shares of e-commerce platform company Shopify (SHOP -2.85%) trade around $42 per share as of this writing, far below their highs of $169 per share. But the price per share tells you little about whether it's cheap or expensive for investors today. To understand the actual value, investors need to know the total value of all the shares and compare that to the fundamentals of the business.
Hopefully that doesn't sound too intimidating, because in this article, I'm going to explain Shopify's slowing growth in the context of the stock's value -- helpful in determining whether the stock is a buy today. And I believe it can all be discussed simplistically.
Shopify stock is still expensive
One share of Shopify may cost about $42. But the company ended 2022 with almost 1.3 billion shares total. Doing the math gives you the total value of the company -- the market capitalization. Therefore, Shopify's market cap is about $54 billion.
How do we know if Shopify is really worth $54 billion? In 1987, investing great Warren Buffett had this to say about the process he and his investing partner Charlie Munger use: "Whenever Charlie and I buy common stocks for Berkshire's insurance companies...we approach the transaction as if we were buying into a private business."
A person with $54 billion at their disposal -- like Buffett -- would ask questions about Shopify's business before buying the company outright. They'd want Shopify to produce more than $54 billion for them over the long haul, to recoup their investment and get richer.
Therefore, our hypothetical investor might look at Shopify's revenue for starters. Shopify generated $5.6 billion in revenue in 2022, meaning it trades at almost 10 times its sales, which is quite expensive even though the stock is way down.
SHOP PS Ratio data by YCharts
A private investor would also look at Shopify's profits before buying the company outright. The company had an operating loss of $822 million in 2022.
In summary, Shopify stock trades far above its revenue rate and it's currently losing money, which points to it being an expensive stock even though it's down 75% from its all-time high.
Is Shopify stock still a buy anyway?
Whether in public markets or from private investors, expensive businesses are frequently purchased anyway. Why? The only reason to buy something expensive (overvalued) is because it will be worth more in the future than it is today, justifying today's price. That typically happens through business growth.
For evidence, consider that business management company Boston Consulting Group published a study in 2006, reviewing top stock market performers. It found that many high-growth companies performed poorly over long time periods. However, it also found that among the top quartile of performers, 60% of their performance was driven by growth over 10-year time frames.
In other words, not all growth stocks perform well. But most companies that perform well can attribute success to their growth.
When it comes to growth, Shopify has never been lacking. The company went public in 2015 and generated $205 million in revenue that year. In the short seven years since, Shopify's revenue is up an astounding 27 times.
However, Shopify's top-line growth is slowing dramatically, as the chart below shows.
SHOP Revenue (Quarterly YoY Growth) data by YCharts
Shopify's revenue was only up 21% year over year in 2022, a big drop from its 57% growth in 2021. Moreover, management only expects growth in "the high-teen percentages" for the first quarter of 2023 -- potentially its slowest quarterly growth rate as a public company.
Therefore, Shopify is an expensive stock. Its price tag potentially could be justified with enough growth. However, its growth is slowing dramatically.
Does this mean that investors should sell Shopify stock? Not necessarily. Shopify does have ways to reinvigorate its top-line growth. For starters, it's raising its prices for existing customers -- at least 33% for monthly plans and more than 100% for annual plans. The price increases don't start until April 23, meaning the growth rate in the second quarter and second half of 2023 could be far greater than that in Q1, assuming it retains customers at the higher price points.
Moreover, e-commerce is still a secular growth trend, providing an ongoing tailwind for Shopify's business for years to come. In short, Shopify's growth days aren't necessarily over yet.
For me, the takeaway is that Shopify's expensive valuation and slowing growth combine to make this a riskier stock for investors today. That doesn't necessarily mean investors should sell -- as we've seen, there are ways Shopify can return to stronger growth rates. However, for new investors, it may not be a buy right now either, especially since there are other high-reward opportunities with potentially less valuation risk.
