- The market’s de-rating of Shopify is justified given slowing growth and the overall contraction in growth stock valuations.
- Similar to what played out with AMZN stock 20 years back, SHOP could make a partial recovery within a reasonable timeframe.
- However, before that rebound happens, investors should watch out for another sharp decline.
Spiking back after hitting price levels last hit in early 2020, you might think Shopify (NYSE:SHOP) has finally bottomed out. Down more than 64% from its all-time high, now’s the time to buy SHOP stock, right?
Not so fast. The e-commerce software provider may seem like a bargain worth buying after tech’s extended selloff, sparked ahead of the Federal Reserve’s rate increases. With the market reacting positively to the initial rate hike, it may seem like the worst is over. However, there’s no guarantee that’ll be the case.
With its revenue and earnings growth slowing, SHOP stock is unlikely to rise anywhere near its past high-water mark. In time, a partial price recovery may be possible. But shares could take another dive before then.
| SHOP | Shopify | $685.43 |
The SHOP Stock Selloff Was Not an Overreaction
The big shift in sentiment for growth and tech stocks may have been due. Still, you might believe the market overreacted with SHOP stock, bidding down shares with the same fury given to tech names with questionable prospects.
However, taking a closer look, it’s clear the high double-digit percentage drop for SHOP stock was justified. That’s because its growth is slowing down. Pandemic tailwinds are long gone. In its most recent guidance, the company stated revenue growth, which came in at 57% last year, will slow this year.
With deceleration ahead, it made little sense for shares to keep trading well above $1,000 per share. That’s not to say growth is coming to a screeching halt. The sell-side estimates Shopify’s top line will grow 31.4% in 2022 and another 32.7% in 2023. It expects to see a decent amount of earnings growth during this period as well.
The fact it’s already out of the red puts it well ahead of other former tech favorites, many of which have not yet become profitable. It may also signal SHOP stock does have a chance of making a partial recovery. However, before buying, keep in mind it may fall to even lower prices.
Shopify Could Drop Before It Begins a Recovery
We’ve established the big drop for SHOP stock was not unreasonable. Hence, one could argue it’s currently trading at a fair value — or, at least a sustainable price until the company’s growth catches up.
That’s disappointing for those looking at it as a near-term trade. But it’s not necessarily a deal breaker for those looking to hold it for several years. It could deliver middling returns before making a partial recovery.
That’s what happened with Amazon (NASDAQ:AMZN) twenty years back following the dotcom bubble. Between 1999 and 2001, AMZN stock fell more than 90% before starting to make a recovery.
Admittedly, Shopify is a lot more established than Amazon was in 2001. A 90% drop from its high water mark would really be overdoing it.
The company is expected to report earnings around $5.03 per share next year. Moving 90% below its all-time high would send it to about $176.29 per share, or around 35x this estimate.
Even so, a move to, say, $300 per share does appear possible. If that were to happen, SHOP would trade for nearly 60 times next year’s earnings. One could argue this is a fair value for a business that’s seeing its annual rate of growth decelerate to around 30%.
If You Buy SHOP Stock, Expect to Be Frustrated
Over a long enough timeframe, buying into Shopify today could end up being a profitable move. But in the short- to mid-term, it could be a frustrating experience.
Shares could see another double-digit percentage drop before the dust settles. Keep in mind, my thesis assumes it will continue to grow. It’s unclear whether a possible recession in the coming year could prevent it from delivering results in line with expectations.
If you decide to take the plunge with SHOP today, chances are you’ll need patience and a strong stomach.
On the date of publication, Thomas Niel did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.