Shopify (SHOP 1.11%) has been impressing investors with its continued high growth along with effectively bringing down expenses. Investors had been pushing up Shopify's share price because they've been confident that Shopify could make that happen. It operates an excellent business with tons of opportunity, and once it straightens out its costs, it looks like it could be unstoppable.
However, despite excellent fourth-quarter results full of the progress investors were looking for, Shopify stock has been a mediocre performer so far in 2024. In fact, it's actually slightly down right now. Should investors be worried?
Shopify has an incredible business
Shopify does a lot more than offer e-commerce web packages for small businesses. It provides a large range of services that help its clients succeed, and it targets businesses of all sizes. It made that pivot by becoming a full e-commerce platform, where any business can find some kind of product that can boost its sales.
So on top of its millions of small business clients, it now features high-profile names like Carrier and Allbirds. These businesses are crucial to Shopify's growth story because they're way more lucrative than the typical small business.
Something I love about Shopify is that it continually launches new products and services. Each of these leads to incremental progress, and together, they create a growing and sustainable business.
In the 2023 fourth quarter, gross merchandise volume (GMV) increased 23% to $75.1 billion, and revenue increased 24% to $2.1 billion. That's particularly impressive when viewed in comparison with other e-commerce retailers like Amazon. Amazon controls the e-commerce market by a wide margin, but its own online store growth increased 9% year over year in the fourth quarter to $70.5 billion.
What is there to worry about?
I think Shopify has an incredible future ahead of it as an important element in the infrastructure of e-commerce. It has carved out a solid niche that's hard for competitors to crack, offering perhaps the widest array of services that an e-commerce retailer could need.
But Shopify stock is expensive. At the current price, it trades at a price-to-sales ratio of 14. That's quite rich when compared to other e-commerce companies, even when factoring in its robust growth rates.
And that's compounded by the fact that Shopify is still working hard to maintain profitability. It faltered when it built out too much to address booming demand early in the pandemic, but it's been effectively rolling that back. The company reported positive operating and net income in Q4, with a 13% operating margin. This comes after hanging out below zero for a while.
SHOP Operating Margin (Quarterly) data by YCharts
Management noted that it's bringing in cash -- it generated more than $900 million in free cash flow in 2023 with a 13% margin after an outflow in 2022. It's expecting a margin in the low single digits in the 2024 first quarter, and then to see incremental growth.
Paying attention to cash in place of operating income strips out many non-cash items on the income statement and often tells a more complete story about a company's financial position, so that's great news. But it's also something that has to be sustained for a longer period.
Is Shopify stock too expensive?
This brings to mind Warren Buffett's exhortation to buy great businesses at fair prices instead of fair businesses at great businesses. Shopify is a great business, and this is not a great price. But is it a fair price? Buffett is also the king of value investing. So his definition of a fair price is still likely to be below the market's.
Investors may finally be realizing that Shopify's growth needs to catch up to its share price. If you don't already own shares, I would recommend waiting for the share price to more logically reflect Shopify's performance and opportunities. If you have a long time horizon and can afford to let your money sit for a while, you can buy shares now and ignore them for a few years. But active investors should keep an eye on Shopify stock and wait for a more attractive entry point.
