One of the core tenets of successful investing is to buy good companies at a reasonable price and hold them for the long run. While this strategy may sound simple, it is not easy to execute since it takes work to find these companies, let alone buy them at attractive prices.
Maintaining a watch list of companies you're interested in is therefore an excellent way to keep track of their developments over time and buy them when Mr. Market offers the right opportunity. And one company that should make it onto investors' watch lists in 2024 is Shopify (SHOP 1.11%).
Shopify made a solid comeback in 2023
Like most e-commerce companies, Shopify saw a surge in growth when the pandemic hit. For example, gross merchandise value (GMV) rose 96% to $119.6 billion in 2020, and revenue jumped 86% to $2.9 billion the same year.
Yet, the global economy reopening and a series of adverse developments in 2022 -- including geopolitical challenges and a weak macroeconomy -- brought enormous headwinds to the company. As a result, GMV increased just 12% in 2022, hitting a low of 11% growth in the second and third quarters that year. Revenue growth slowed to 21% too, which would have been worse had Shopify not raised its subscription prices.
Fortunately, the worst seems to be behind the company. A tight lid on expenses and exit from the logistics business have been key to the company's recovery. Shopify's growth rate is already showing signs of improvement. For example, GMV was up 22% year over year in the third quarter. Similarly, revenue grew 25% (or 30% if excluding the impact of the disposal of the logistics business). And free cash flow turned around from negative $148 million a year ago to a positive $276 million result in the third quarter.
Looking ahead, Shopify must prove its recovery is sustainable. In other words, investors should continue to closely monitor its performance in the coming quarters.
Shopify has a huge untapped opportunity
Shopify has been a remarkable growth stock, growing revenue more than 25-fold from $205 million in 2015 to $5.6 billion in 2022. The good news is that it will likely continue growing for years, even though it's already a leading player in e-commerce.
Consider this: Shopify's market share covered about 10% of U.S. e-commerce sales in 2022 (based on GMV), and e-commerce sales overall represented just 16% of the total retail sales that year. Moreover, Shopify is no longer just an e-commerce platform but has expanded to serve merchants' brick-and-mortar needs via Shopify POS, which offers both hardware and software to help businesses sell offline. In short, the company has yet to scratch the surface of this vast opportunity.
It has also expanded its offerings to overseas markets. As part of its international expansion, Shopify is making it easier for existing merchants to sell to overseas customers by providing them with tools like translation, payments, and shipping. For perspective, Shopify enabled $28 billion in cross-border sales in 2022, which will continue to grow in the future.
Investors have good reason to remain optimistic about Shopify's growth momentum in the coming years.
But Shopify stock is not cheap
Shopify's recent momentum has breathed new life into the stock. After falling 85% from their all-time high, shares surged 124% in 2023. Still, investors shouldn't rush into the stock, at least not until they consider its valuation.
The stock trades at a price-to-sales (P/S) ratio of 14.4 as of this writing, while competing e-commerce giants like Amazon and Alibaba trade at P/S ratios of 2.7 and 1.5, respectively.
While the bulls may argue that Shopify's premium valuation is warranted thanks to its substantial growth prospects, conservative investors should think twice before buying in. If Shopify fails to keep up with investors' expectations -- such as failing to sustain its recent recovery -- investors may once again rerate the stock at a lower valuation.
Investors should keep Shopify stock on their watch lists for now. For it to become a must buy, the company has to deliver a few more quarters of solid numbers or the valuation must come down (or both).
