Is It Too Late to Buy Shopify Stock?

Shopify's (SHOP 1.25%) stock price soared 24% on May 4 after the Canadian e-commerce services provider posted its first-quarter report. Its revenue rose 25% year over year to $1.51 billion and beat analysts' estimates by $70 million. Its adjusted net income dropped 52% to $12 million, or a $0.01 per share, but still cleared the consensus forecast by $0.05 per share.

Shopify's earnings beat suggested its business was finally recovering from its post-pandemic slowdown that had been exacerbated by inflation over the past year. But is it too late to buy the stock after its post-earnings pop?

Image source: Getty Images.

Has Shopify finally stabilized its business?

Shopify's e-commerce services enable smaller merchants to set up online shops, process payments, fulfill orders, and manage their own marketing campaigns. That flexibility makes it a popular option for merchants who don't want to join a massive third-party marketplace like Amazon (AMZN 0.58%).

Shopify gauges its growth in terms of gross merchandise volume (GMV), or the value of all goods sold on its platform; gross payment volume (GPV), or the value of all its Shop Pay transactions; and its total revenue. By reviewing those three metrics over the past four years, we can see how the pandemic generated unprecedented tailwinds for its business throughout 2020 and 2021 -- and how quickly they dissipated in 2022.

Data source: Shopify. YOY = year over year.

Shopify faced tough year-over-year comparisons in 2022 as brick-and-mortar stores reopened, inflation curbed consumer spending, and Apple's privacy changes on iOS made it difficult for Meta Platforms' Facebook and Instagram to craft targeted ads. Many of Shopify's merchants rely heavily on Facebook, Instagram, and other social media ads to drive shoppers toward their online stores.

That's why investors breathed a sigh of relief when Shopify's first-quarter growth rates showed some signs of stabilization. Its year-over-year GMV and GPV growth rates both accelerated from 13% and 23%, respectively, in the fourth quarter.

During the conference call, President Harley Finkelstein mainly attributed that ramp-up to the expansion of its merchant base, with "strong growth across all geographies and merchant sizes." Additionally, its rising overseas penetration rates (15% of its GMV came from cross-border sales) and the adoption of its point-of-sale systems by brick-and-mortar merchants (which boosted its offline GMV by 31% year over year) also helped.

Making some deep cuts to boost its margins

Shopify's top-line growth might be stabilizing, but that only addresses half of the bearish thesis. The other half focuses on its adjusted operating margin, which plunged from 16% in 2021 to 0.1% in 2022 as it ramped up its spending. 

One of those major investments was its logistics network, which it launched in 2019 and expanded through its acquisitions of 6 River Systems and Deliverr. But instead of building a third-party logistics (3PL) network like Amazon, Shopify built an asset-light fourth-party logistics (4PL) business that merely brokered warehouse space for its merchants across existing 3PL networks. But instead of saving it money as planned, that approach crushed the company's margins because it became a middleman with no real pricing power. Its merchants also weren't satisfied with Shopify's fragmented fulfillment network.

That's why Amazon, smelling blood, last year launched its "Buy with Prime" buttons that tethered independent merchants to its own payment and logistics services. That move was so alarming that Shopify explicitly warned its merchants that adding Amazon's buttons to their sites would violate its terms of service.

Faced with all those challenges, it wasn't too surprising when Shopify announced it would sell its entire logistics division to Flexport in exchange for a 13% stake in the private company. Shopify also plans to lay off about 20% of its workforce to further streamline its business. All of those cost-cutting measures could finally boost its adjusted operating margin, which dropped another 5 percentage points year over year to negative 3% in the first quarter of 2023.

Is it too late to buy Shopify?

Shopify didn't provide exact guidance for the second quarter, but it expects its revenue to increase at a "similar" year-over-year rate as Q1 as its adjusted operating expenses drop by a "mid-single digit percentage" sequentially.

For the full year, analysts expect Shopify's revenue to rise 19% to $6.7 billion as its adjusted EPS stays flat. But based on those estimates and Shopify's enterprise value of $53.5 billion, its stock still isn't cheap at 8 times this year's sales.

By comparison, Amazon -- which is admittedly growing at a slower rate than Shopify -- trades at just 2 times this year's sales. The Latin American e-commerce and fintech leader MercadoLibre, which is growing at a much faster rate than Amazon and Shopify, trades at 5 times this year's sales.

Shopify is taking some steps in the right direction, but its valuation still doesn't fully reflect its macro and competitive challenges. Therefore, I'd still avoid Shopify's stock and wait for it to cool off to more reasonable levels.