- Shopify (NYSE:SHOP) stock is off over 61% from its November peak and also down 52% since the end of 2021.
- Analysts are still positive on the stock, but with higher rates coming consumer spending could slow in the second half.
- This may not be adequately reflected yet in SHOP stock, despite its bounce off a recent trough price.
I have been consistently negative on Shopify, given its huge overvaluation and high price in relation to its fundamentals. This is despite the company’s good revenue growth. The problem now is that SHOP stock may not reflect the reality of what will happen with higher interest rates.
This week the Federal Reserve has started raising interest rates, which is the first time since 2018. Now it’s clear that they will have to continue doing so for at least the rest of this year, as it has signaled six more rates rises will occur.
The underlying issue is that inflation is now completely out of control, up 7.5% in the latest CPI index report and likely going higher. In fact, I explained recently how the rate could easily reach 10% by the end of this year.
Rate Increases Will Hurt SHOP Stock
Consumer spending always falls when interest rates increase sharply. Consumer demand tends to be highly price-elastic at the margin, implying that as prices rise, volumes fall, demand slackens and retail revenue growth slows.
This is probably not yet fully or adequately reflected yet into either analysts’ or the market’s view of Shopify’s fundamental outlook. And on top of that SHOP stock could be hurt by its continuing valuation issues, as I have written about in past articles.
Shopify recently suggested as much. They said that there are “secular tailwinds” for entrepreneurs going forward. The company also said that inflation and consumer spending near-term will cause problems for its growth rates.
The problem is this could dramatically slow its growth rates going forward, especially if inflation starts to spike and if stagflation starts to take root.
Where This Leaves the SHOP Stock Valuation
As it stands today, analysts still project robust growth this year for Shopify. For example, Refinitiv’s survey of 24 analysts, published by Yahoo Finance, has an average revenue forecast of $7.65 billion for 2022. This implies a growth rate of 66% over the $4.61 billion in revenue during 2021.
Shopify has a market capitalization of $81.4 billion, even though it has fallen over 61% in the last four months since peaking at $1,690.60 on Nov. 19. As of March 17, it was down to $657.38. The problem is that this may still be too high for SHOP stock, even though it’s well off of its highs.
For example, at a $81 billion market cap, the price-to-sales (P/S) is 10.6 times. This is typically the kind of multiple that applies to earnings not revenue. However, there also seems to be a big discrepancy between analysts’ surveys.
For example, the Seeking Alpha analyst survey of 40 analysts projects that 2022 sales are forecast at $6.05 billion, well below the Refinitiv survey. This implies a sales growth rate of over 31%. But it also shows that the P/S multiple is 13.5 times.
So, not only is there a wide discrepancy between average analyst revenue surveys but there is also a real distinct possibility that revenue could be lower than forecast. That will immediately compress the P/S multiple even further, on top of being too high as it is.
Where This Leaves Investors in SHOP Stock
There is a possibility I could be completely wrong about this. We could do a probability analysis here. For example, let’s say there is a 30% chance that revenue could come in at the high end (the Refinitiv survey). That leaves the stock at the present price, given how high the P/S multiple already is at 10.6x.
Next, let’s say there is a 50% chance that revenue comes in at the Seeking Alpha rate, but that is lower than the market likes. As a result, the P/S multiple falls from 13.5x to 10.6x. This implies a 21.5% drop in the stock price (i.e., 10.6x/13.5-1=-21.5%).
Lastly, let’s say there is a remaining 20% chance (i.e., 30%+50%+20%=100%) that revenue grows just 15%, not 31% as in the Seeking Alpha analysts estimate. That would likely cause a 31% drop in the stock (i.e., $5.3 billion revenue x 10.6x = $56.2 billion, which is 31% below its $81.4 billion market cap today).
So, now we add up all three possible events: a 30% chance the stock stays flat, a 50% chance it falls 21.5% and a 20% chance it falls 31%. The summation of these probabilities works out to a 17% drop in SHOP stock (i.e., 0-10.75%-6.2%=-16.95%).
Here’s the bottom line: Expect Shopify to fall to $545.63 (i.e., 17% below today’s price).
On the date of publication, Mark Hake 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.