The market loved its most recent update.
Shopify (SHOP -3.79%) stock soared 21% in August according to data provided by S&P Global Market Intelligence. It delivered an outstanding second-quarter earnings report, and Shopify is a popular stock that makes big moves based on performance.
Harnessing its huge opportunity
Shopify is a global e-commerce leader, and it’s leveraging its vast and superior capabilities to grab market share in a growing industry. It’s gone through some ups and downs over the past few years, managing through accelerating pandemic demand and then its reverse. It hasn’t been an easy path to tread, but Shopify has continued to report strong growth throughout.
Investors had been worried about guidance for further slowdowns, but Shopify posted a beat in the second quarter, in addition to many other positive updates. Revenue increased 21% year over year, or 25% adjusted for the sale of the logistics business last year.
Shopify makes money in two ways. It has subscription packages, and it processes payments on its platform. The payment processing business is much bigger, accounting for 75% of total revenue in the second quarter. It’s also growing as a percentage of gross merchandise volume (GMV) processed on the platform, up from 58% last year to 61% this year. Subscription solutions revenue continues to increase at a robust pace, up 27% year over year.
Making its business work
There are two concerns investors should be thinking about with Shopify stock. The first is profitability. Shopify has made great strides with becoming profitable, but it’s not yet sustained. As revenue increases, profits have only tentatively been following.
Management has taken clear action to lower costs and boost the bottom line. It cut jobs when demand declined, and it sold off a logistics company called Deliverr that it had recently acquired but that dragged on profits. It’s still feeling the positive impact of the sale, and expects more good news in this regard. However, it’s still working toward generating profitability.
It looked good in the second quarter. Operating income was $241 million and net income was $171 million, both up from severe declines last year related to the sale. Free cash flow more than tripled year over year to $333 million.
The second concern is valuation. Shopify stock trades at a price-to-sales ratio of 12, which is a rich valuation. It demonstrates how much confidence investors have in this stock, but it also leaves little wiggle room for mistakes. That makes it risky.
The likelihood is that Shopify will continue to grow at a steady pace and become sustainably profitable. But some amount of that growth is already baked into the price, and risk-averse investors might want to look for something else.
Jennifer Saibil has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Shopify. The Motley Fool has a disclosure policy.
