Shares of e-commerce and payment platform provider Shopify (SHOP 0.66%) plunged following the company's first-quarter earnings release this week. Is the sell-off a buying opportunity or a sign of potentially more trouble ahead?
Shopify's financial results show a fast-growing company. But that doesn't mean the stock is a buy. The company's market capitalization, currently standing at around $80 billion, necessitates both strong top-line growth and a clear path to substantial profits. It's delivering on the former but not on the latter. Consistent and robust profitability remains elusive -- a big red flag for a company with such a significant market cap and probably a reason to avoid the stock.
What Shopify is getting right
The e-commerce company's first-quarter top-line performance was solid. Total first-quarter revenue rose 23% year over year. Even more, when adjusting for the sale of its logistics business, revenue actually rose 29% year over year -- an acceleration from 24% growth in the fourth quarter of 2023.
Its revenue guidance was also notable. Management guided for second-quarter revenue to grow at a rate in the high teens on a year-over-year basis, or "in the low-to-mid-twenties when adjusting for the 300 to 400 basis points impact from the sale of our logistics businesses," the company said in its first-quarter earnings release. Though this would mark a deceleration from Shopify's organic revenue growth of 29% in Q1, it would still make for solid growth considering the tough comparison Shopify is up against during the quarter; the company raised its platform prices in the year-ago quarter, bumping up its revenue growth rate for the period to 31%.
A disappointing bottom line
But here's the issue: Shopify's expense structure remains extremely high, even after recent layoffs. Operating expenses for the quarter were $871 million, accounting for 91% of its gross profits. Sure, this produced an operating profit of $86 million, up from an operating loss of $193 million in the year-ago quarter. However, this is a small figure when compared to the company's massive $80 billion market cap.
But it gets worse. After including its irregular expenses for Q1, Shopify actually reported a significant loss for the period. Its net loss was $281 million, or $0.21 per share. Further, Shopify expects its second-quarter gross margin to narrow. Management guided for it to worsen by about 50 basis points sequentially.
While it's good to see a year-over-year improvement in Shopify's operating profit, the company has a long way to go before its bottom line lives up to the stock's valuation.
A pricey valuation
No matter how you slice it, Shopify looks like an expensive (and probably overpriced) stock. Shares trade at more than nine times sales, and the company is operating at a net loss on a trailing 12-month basis. Given the business's lack of profitability, justifying the stock's $80 billion valuation requires some good imagination.
To be fair, the business is doing great in isolation. As Shopify president Harley Finkelstein said in the company's first-quarter earnings release, "You're seeing the strongest version of Shopify in our history." I believe this. But when you consider the business fundamentals in the context of its stock's valuation, it's a disappointment.
