Share prices of Shopify (SHOP -8.62%) have gotten absolutely demolished as of late. After reaching an all-time high of $1,762.92 per share on Nov. 19, 2021, Shopify stock is now down a staggering 70% in less than six months.
In retrospect, Shopify stock probably got ahead of itself. But its valuation is finally showing signs of being more reasonable for investors who have been waiting for the chance to consider Shopify. Here’s why Shopify is my top growth stock to buy in May.
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A bird’s-eye view of e-commerce
Probably the simplest reason for investing in Shopify is a belief in small business and retail sales shifting online. The COVID-19 pandemic accelerated e-commerce adoption. But online sales are still a small slice of the total retail pie.
According to the Census Bureau of the Department of Commerce, e-commerce sales were $870.8 billion in 2021 and made up 13.2% of total U.S. retail sales, compared to 13.6% of total retail sales in 2020. In 2021, Shopify supplied 10.3% of e-commerce sales in the U.S. That means that Shopify fueled 1.36% of total U.S. retail sales — which is amazing, considering how young the company is.
An investment in entrepreneurship
Estimates vary, but small businesses make up roughly 40% to 50% of U.S. gross domestic product (GDP). Shopify has large clients. But the spirit of the company is centered around small and medium-sized businesses (SMBs). After all, its mission is “making commerce better for everyone.” In this sense, Shopify is trying to empower individuals to get creative and build a business without the overhead required of a physical store.
While companies like Wix.com or Squarespace are arguably better than Shopify for websites that aren’t centered around selling something, Shopify’s easy-to-use cloud-based software takes the cake for serious sellers. Shopify provides optionality when it comes to the look and feel of the site, which payment process to use, which shippers to use, customizing discounts — you name it. Its three different payment plans make it easy to gain access to more services as a business grows.
For example, the advanced $299 per month option provides more staff accounts, inventory locations, and advanced reporting, as well as automates certain e-commerce functions, connects with third-party shippers to save on rates, and provides discounts on credit card rates and transaction fees.
A business that makes sense
What I love most about Shopify is that it is an easy-to-understand business, even if you’ve never actually used it from the merchant’s perspective. Shopify makes money in two ways — from Subscription Solutions and Merchant Solutions. Subscription Solutions grow when more customers open a Shopify store or when existing customers upgrade from the $29-per-month basic plan to the $79-per-month Shopify plan or from the Shopify plan to the aforementioned advanced plan. Subscription Solutions accounted for 29.1% of 2021 revenue and 31% of 2020 revenue.
Shopify makes most of its money from Merchant Solutions, which exceeded $1 billion in revenue in Q4 2021. Merchant Solutions are fees that Shopify customers incur for shipping, payment, or point-of-sale tools. The main driver of merchant solutions is gross merchandise volume (GMV). GMV is a fancy way of saying the total dollar amount that passes through Shopify and its related apps and channels.
Like eBay and other e-commerce platforms, Shopify makes money off of transactions. So the more money its merchants make, the more Shopify makes. In this sense, it’s not just about customers opening more sites using Shopify — it’s also about those customers’ ability to grow their businesses.
What makes Shopify’s business model attractive is that Shopify generates a foundational amount of money from subscriptions but then gets upside from its customers via its Merchant Solutions division. Therefore, Shopify’s merchants and Shopify have the same interests, and Shopify wins when its merchants win. This is a completely different business model from other software-as-a-service (SaaS) businesses like Adobe — which doesn’t really care if their customers are doing well, so long as they pay their Creative Cloud subscription bill.
An expensive but attractive investment opportunity
As compelling as the buy case is for Shopify, the stock has a forward 2023 price-to-sales ratio of 5.29 and a 2023 forward price-to-earnings ratio of 66.06. It is not cheap by any means, even though, as mentioned, it is down over 70% from its all-time high.
But for investors who feel as though they missed out on Shopify, the pullback could be the perfect time to open a starter position in what is an exciting high-risk, high-reward company with a potentially bright future.
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