Sky-High Valuation Is a Real Problem for Shopify Stock

The past year has been a great one for Canadian ecommerce firm Shopify (NYSE:SHOP). Shopify stock has been on a tear since the start of 2019 with the share price more than doubling over the past six months.

Impressive profit growth combined with a solid business model has kept investors bullish on Shopify stock despite numerous warnings about the security’s bubble-like behavior. At $306 per share, SHOP has bucked bullish calls for months, but will gravity eventually catch up with the e-commerce winner?

There’s certainly a lot to like about Shopify. The firm helps businesses make their products available online through a platform that they can easily integrate with a variety of ecommerce websites.

A Closer Look at Shopify

Shopify is benefitting from the fact that merchants are turning toward a more decentralized selling process, in which they can reach buyers directly through a variety of channels. That has helped SHOP grow its total merchants exponentially over the past few years while keeping margins high. It’s been a pretty effective recipe for success that traders have been gravitating toward.

Shopify’s business looks likely to thrive in the future as ecommerce continues to dominate the retail landscape and small businesses look for ways to put themselves on a level playing field with their larger competitors. SHOP’s suite of services that help merchants with everything from shipping to payments should help the firm grow its client base and tie existing clients into its platform further. 

The bottom line on the bull case for SHOP stock is that the security represents a solid business with a bright long-term future. 

Shopify Faces Challenges

While no one can argue against the validity of Shopify’s business model they can argue that SHOP stock has simply gotten too big for its britches. Shopify stock trades at 534 times its forecasted earnings. To put that into perspective, the average for the IT sector is just 19. Sure, Shopify has a compelling growth story, but it’s not that compelling.

Not only does that make SHOP and expensive play, but it adds a layer of risk as well. Such a high valuation suggests that investors are expecting big things from the ecommerce platform, and it would be irresponsible to assume that the firm will always deliver. Shopify, like all companies, will stumble at some point and the consequences will likely be disastrous simply because of the sky-high expectations.

There are plenty of potential pitfalls on the horizon for SHOP stock as well. For one thing, much of Shopify’s success is dependent on the firm’s relationships with larger firms like Amazon (NASDAQ:AMZN) and Facebook (NASDAQ:FB) and any change in those relationships could weigh on Shopify’s future growth.

That should be at the top of investors minds right now as regulators clamp down on data usage, targeted advertising and social media advertisements.

Plus, the quality of Shopify’s merchants has also come into question. Some Shopify merchants “dropship” their products- meaning they sell foreign products at higher prices and ship the inventory direct from the foreign manufacturer. While there’s nothing illegal about dropshipping, but it does cause friction when products don’t arrive on time or are of poor quality.

Finally, there’s also the concern that Shopify’s client base, primarily small business owners, will be hardest hit by an economic slowdown. As Shopify makes the majority of its money on individual transactions, a recession could significantly alter the firm’s growth projections. 

The Bottom Line on Shopify Stock

The bottom line for SHOP stock is that it’s simply too expensive to be a buy. I like Shopify’s business model and the firm’s future prospects, but there’s just too much potential for a steep pullback to take a position right now.

If you already own shares of Shopify stock, this could be a profit-taking opportunity but I wouldn’t give up on the long-term bull case. The next 6 months could bring on a SHOP stock correction that will bring the share price back down to earth and create a much better entry point for long-term investors.

Shopify stock is simply over-hyped at present, but the company behind the stock is worth considering should the share price become more reasonable. 

As of this writing, Laura Hoy was long AMZN and FB

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