A great business doesn’t always translate into a great stock.
Shares of Shopify (SHOP 1.02%) have risen more than 20% this month as investors have been encouraged by the company’s strong growth in revenue and gross profit. But investors shouldn’t get too excited. There’s good reason to believe the stock’s recent rebound could be hot air.
Sure, the e-commerce platform company continues to execute well and management seems to be making a lot of good decisions. The problem, however, is the stock’s valuation — the same problem I’ve complained about in several articles about the stock over the last year. The company is simply far from living up to its market capitalization of nearly $93 billion at the time of this writing.
A great business
For its second quarter, Shopify once again delivered strong growth in an uncertain market. The quality of its platform, its go-to-market strategy, and macro tailwinds in e-commerce overall continue to help drive growth for the company. Shopify’s second-quarter revenue rose 21% year over year, or 25% when you adjust for the sale of its logistics business by removing revenue from this business in the year-ago period.
Demonstrating how the company continues to improve its profitability profile, Shopify’s gross profit grew 25% year over year — outpacing its 21% revenue growth for Q2.
“Our results underscore our commitment to providing exceptional value to our merchants through focused operating execution and efficiency,” said Shopify chief financial officer Jeff Hoffmeister in the company’s second-quarter earnings release on Aug. 7.
A bad stock
There’s almost no doubt that Shopify will continue to grow its top and bottom line for years to come. The issue, however, is how the company’s underlying profits measure up to its stock’s valuation. Despite boasting a market capitalization of $93 billion at the time of this writing, second-quarter net income was just $171 million — and nearly half of this ($80 million) was interest income. Even if you were to extrapolate the company’s $333 million in free cash flow during the quarter forward three more quarters, the stock trades at about 72 times free cash flow.
Of course, Shopify’s free cash flow arguably makes the business look more profitable than it really is because it excludes Shopify’s stock-based compensation, which came in at $106 million in Q2 alone. While this is a non-cash expense, it still does have the very real cost of diluting shareholders’ ownership.
A free cash flow ratio of 72, even if it may not be the best way to value the stock, might be at least within the realm of reason if Shopify’s revenue growth rate was accelerating. But it’s not. Adjusted for the sale of its logistics business, Shopify’s second-quarter revenue rose 25% — down from 29% adjusted growth in the first quarter of 2024.
Though I’d love to be a part of Shopify’s long-term growth story, I’m not willing to buy shares when they’re already pricing in extraordinary long-term growth in both revenue and profits. I’d rather wait to see if I get an opportunity to buy the stock at a discount to a conservative estimate of its intrinsic value.
What if shares never dip enough to convince me to buy? No problem. There are always other stocks to consider.
Daniel Sparks and his clients have no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Shopify. The Motley Fool has a disclosure policy.
