It has been a fruitful ride for long-term Shopify (NYSE: SHOP) investors. Since its IPO, the stock has risen by more than 1,300%, turning $1 into more than $14. Recent investors, however, face a different fate altogether. Anyone who bought the stock 12 months ago would have lost more than 70%.
Frustrated investors (especially the newcomers) probably want to know what caused the recent plunge in the value of Shopify shares. While we cannot be sure, here are some potential reasons.
Shopify’s growth slowed to a two-year low
Shopify was a massive beneficiary as the COVID-19 pandemic unfolded over the past two years. Stuck at home, shoppers had to rely on online shopping to get daily supplies. Meanwhile, merchants scrambled to move their businesses online to stay afloat during the lockdown and to serve the increased demand from online shoppers.
The result was a massive surge in demand for Shopify’s tools and services. Revenue jumped 86% in 2020 and increased 57% in 2021. But the reopening of economies around the world meant Shopify couldn’t sustain this massive level of growth.
Folks tired of staying indoors rushed back to the physical stores. The e-commerce penetration rate (e-commerce share of total retail sales) in the U.S. fell from 15.7% in the second quarter of 2020 to around 12.9% in Q4 2021. That trend impacted all companies in the e-commerce industry, including Shopify.
In the first quarter of 2022, Shopify’s gross merchandise value (GMV) and revenue increased just 22% and 16% year over year, respectively. While solid, these numbers disappointed investors who were expecting continued sky-high growth. It’s likely many panicked and sold the stock.
Investors are avoiding growth stocks
Slower growth is bad enough, but Shopify has had to face other external challenges.
Topping the list is the general shift in investors’ sentiment — from optimistic to pessimistic — toward the high-growth (but unprofitable) company. While we cannot pinpoint the exact reason, a few potential factors are causing this. One is the rising inflation in the economy, which has already resulted in multiple hikes in interest rates, with more expected in the coming quarters.
A higher interest rate environment is bad for stocks, particularly for high-growth businesses like Shopify. As the young tech company would generate most of its cash flow in the distant future — it is still unprofitable — a higher interest rate will reduce the present value of these future cash flows. In other words, Shopify’s intrinsic value will fall as the interest rate rises. Investors naturally move away from stocks with declining value.
Besides, investors are switching from an expansionary mindset to preservation mode in an increasingly volatile external environment plagued by economic challenges and geopolitical tensions (such as the war in Ukraine). There is anecdotal evidence that investors now prefer well-established and profitable companies — like Berkshire Hathaway — over high-growth but loss-making companies.
It does not help that Shopify has been trading at a lofty valuation throughout its history, averaging a price-to-sales (PS) ratio above 30 over the last five years. Even after the correction, the P/S ratio remains elevated at around 11 (as of this writing).
What to expect from Shopify
The beginning of 2022 was unremarkable for Shopify (especially if we compare it to recent trends). A silver lining here is that management expects that growth in the fourth quarter of 2022 will be the highest of the whole year, indicating that it could pick up in the coming quarters.
Over the longer term, there are good reasons to expect Shopify will expand at high rates — even if the growth rates cannot match those of the peak COVID period. After all, the e-commerce penetration rate in the U.S. is still low, and further penetration will benefit all e-commerce companies. Besides, Shopify has multiple growth levers to pull, including attracting new customers, increasing customers’ wallet share via adding new tools, and entering new geographies.
In short, it will be a while before Shopify exhausts all its growth opportunities.
Lawrence Nga has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Berkshire Hathaway (B shares) and Shopify. The Motley Fool recommends the following options: long January 2023 $1,140 calls on Shopify, long January 2023 $200 calls on Berkshire Hathaway (B shares), short January 2023 $1,160 calls on Shopify, short January 2023 $200 puts on Berkshire Hathaway (B shares), and short January 2023 $265 calls on Berkshire Hathaway (B shares). The Motley Fool has a disclosure policy.