Wow, what a difference a year can make. After falling close to 90% from all-time highs, Shopify (SHOP 1.11%) has roared back with a vengeance since the start of 2023, with shares up over 120% since Jan. 1, 2023, as of this writing. That is around four times the return of the S&P 500 over that same time period.
Investors are heaping praise on the Canadian technology player, and for good reason. Shopify recently passed a numerical milestone, hitting a $100 billion market capitalization, one of approximately 150 companies worldwide to pass this financial threshold.
The e-commerce platform is firing on all cylinders as merchants adopt its payment solutions and it seamlessly implements price increases. Profit margins are inflecting higher, with operating margin surpassing 10% for the first time since 2021's last quarter.
Should you buy some shares of Shopify after it has passed a market cap of $100 billion? Or is now the time for investors to hit the brakes?
Profits are here, and growing quickly
Shopify recently released its fourth-quarter earnings results, and the report was a doozy. Revenue grew 21% year over year to $2.1 billion in the period, which would have been 30% growth if you excluded its recently sold logistics operation. Profits were healthy across the board, with gross profit up 33% (outpacing revenue growth) and operating income of $289 million. That gives Shopify a 14% operating margin. Last year in the same quarter, Shopify posted a negative 5% operating margin.
A key to Shopify's increasing operating leverage is the momentum it is gaining with its Shopify Payments solution. Sixty percent of payments processed through Shopify websites were with its own payment solutions, which generates much higher revenue per transaction with minimal incremental costs. And this isn't a small chunk of spending, either. Just in Q4, Shopify processed $45 billion in payment volume through its own solutions. This staggering sum shows how valuable Shopify has become to the e-commerce sector at large.
Management has spent the last few years trying to get more efficient after over-hiring during the 2020 and 2021 pandemic-driven e-commerce boom. Now, investors are seeing the fruits of these changes as the operating margin inflects higher. With gross margin above 50%, Shopify has room to further grow its profit margins, with operating margin greater than 20% likely doable within the next few years.
Shopify has pricing power. The question is: how much?
Shopify's payment solutions segment is now the majority of Shopify's revenue and was its main growth driver over the past five years. It is now showing signs of slowing down.
But Shopify began over a decade ago with a different business model: software subscriptions for e-commerce websites. This is still a part of Shopify's operations, but is now less than 25% of overall revenue as management prioritized customer acquisition and payment revenue instead of optimizing subscription prices.
This prioritization may reverse over the coming years. Shopify has begun implementing major price increases in recent quarters for its software subscriptions. For example, it just boosted its top tier from $2,000 a month to $2,500 a month. Its basic business plan is now $49 a month, with the cheapest tier at $19.
You might think it is risky for Shopify to start raising prices this quickly. But there has been zero talk of customer churn. Why? Because Shopify now provides an incredible amount of value to its merchants that is still far greater than the price it charges for these subscriptions. Amazon didn't raise the price of Prime from $79 to $139 without adding new benefits for its shoppers.
Shopify is doing the same for its merchant customers. Almost everything an e-commerce business needs can be run through Shopify's software solutions, from inventory management to global distribution to customer analytics. With how vital the platform has become to these customers, I think Shopify has significant room to raise prices before seeing any customers leave. In turn, this should give it a long runway to grow its high-margin subscription solutions segment.
So, is the stock a buy or not?
It's clear right now that Shopify is a great business. But with a great business comes great expectations, which are embedded in this stock right now. At a $100 billion market cap, let's see how high these expectations are for anyone who chooses to buy shares today.
In 2023, Shopify generated $7 billion in revenue. Let's assume the company -- due to the growth of e-commerce, pricing power, and its payments revenue -- can grow revenue by 20% for the next five years. That would bring revenue to $17.4 billion in five years. Let's also assume its profit margin can reach 20% in five years. That equates to $3.5 billion in annual earnings in year five.
Take $100 billion and divide by $3.5 billion and you get a five-year forward price-to-earnings ratio (P/E) of 28.5. This is above the S&P 500's P/E right now. This indicates to me that the expectations for Shopify stock are sky-high at the moment, meaning it will be hard for the stock to do well over the next five to 10 years. Investors would be correct in pumping the brakes on buying Shopify right now.
