Romans Chapter 8 verses 35 and 37 state, "Who shall separate us from the love of Christ? Shall trouble or hardship or persecution or famine or nakedness or danger or sword? No, in all these things we are more than conquerors through him who loved us."
I've recently gone through some family health issues and it's always tough. The natural tendency I have is to ask God why. Usually, the response is............ What I do know is that I have a big God and small problems, not the other way around. I know God loves me regardless of my situation, and that Jesus Christ's defeat of death on the cross means that regardless of the troubles today, eternity will be an entirely different story. Victory has already been taken.
When it comes to investing, the challenges and struggles can feel like a ton of bricks hitting. How do I deal with a crashing market targeting aggressive growth primarily when that is what my portfolio is built upon? It's not easy, but just as I need to trust God in my times of difficulty, I need to trust the parameters and strategies that I have set in place to deal with undue volatility and pressure.
I've got my sights set on Shopify, Inc. (SHOP) and for good reason. The company is the clear number two behind Amazon, Inc. (AMZN) with respect to e-commerce GMV in the U.S. At the same time, Shopify witnessed some impressive performance during 2020 and even responded with substantial returns in 2021 as well with 85% growth in 2020 followed by just below 60% growth in 2021.
Unbelievably, Shopify finds its SP back to levels of nearly two years ago in the spring of 2020, immediately following the pandemic. Don't get me wrong, I don't believe that the peak valuation levels for aggressive growth companies during 2020 and mid-2021 were justified. But just as valuations rose to quickly, they have now fallen just as fast to points where the discounts cannot be justified.
Let's take a look at Shopify's fundamental history and mid-term potential.
Shopify has exhibited interesting trends. It is clear that the pandemic led to peak premium valuation levels in 2020 and 2021, but it should be noted that Shopify began to develop an increasing premium prior to the pandemic in 2019 too. Conversely, Cash Flow margins were also beginning to improve with extreme multiples dropping substantially before the pandemic.
Shopify's Net Cash position has always remained strong although the company has continued to use share dilution as the core way to raise capital. Despite this, Shares Outstanding remain fairly low for a Large Cap at just over 125 million. GM has remained stable from 53% to 57%, while Cash Flow inflected strongly in 2020, and has still remained robust even with the contraction during 2021.
For Revenue we can clearly see the substantial increase during 2020 from the pandemic. But as 2020 was coming to an end, analysts were calling for Shopify, among other aggressive growth peers to see substantially slowing Revenue moving forward. For 2021, the company still grew at nearly 60%, with the caveat being that the back-half did end up slowing further. At the company's current scale, recent Cash Flow inflection appears to be positioned to remain.
Shopify breaks down their Revenue by Subscription Solutions (primarily generated from GMV) and Merchant Solutions (primarily generated by GPV). While not exactly 1:1, I feel that the substantial amount of Revenue for each segment can be derived from the Take Rate of each gross level respectively. Merchant Solutions clearly has a much higher Take Rate, but also a far lower GM. Regardless, GP for Merchant Solutions has now eclipsed that of Subscription Solutions.
After reviewing Shopify's earnings report, I find it very interesting that average analyst Revenue estimates are so high. For 2022 and 2023, the 25 average analyst Revenue estimates are $7.7 billion and $10.2 billion respectively. For 2022, this is very interesting as Shopify's guidance was that growth would remain robust, just not anticipated to exceed 2021 levels. Guidance also alluded to the first half being slower versus the back-half.
At any rate, Shopify is poised to continue to see growth over the next few years likely at or above the 40% level annualized. So where does valuation make sense?
Well, I think that it makes perfect sense to not se an EV/Revenue multiple at 25, 30, 40 or 50, which was where 2020-2021 was at. But I do believe that Shopify is justified seeing this multiple somewhere in the 15 to 20 times range. Over time as the company continues to scale and transition towards mid- and long-term segment developments, I do expect that further Cash Flow inflection is a strong possibility, north of 20% for OCF margins.
Putting it all together and Shopify is undervalued at today's SP near $650. My average cost basis sits at where I believe Shopify is fairly valued for 2022. I have set a Max AP at $600, which if hit, will trigger a buy action. Why $600 some may ask. The answer has nothing to do with valuation and is solely based on an area that I am looking for to maximize a reduction in cost basis. With the market's illogical volatility of late, there is no reason to get too concerned with "the right price".
Let me be clear on this. For companies like Shopify, Roku, Inc. (ROKU), Teladoc Health, Inc. (TDOC) among others, it isn't about the right valuation right now. Valuation is out the window as selling pressure through panic-selling has taken control. During these times, I pivot towards forgetting about where valuation should be, and focus exclusively on accumulation strategies targeting acquisition of as many shares as possible to defend holdings.
For the North America e-commerce market, Shopify is clearly the best investment option for investors looking for the highest investment returns. For Shopify, $600 is a good level where I would increase the existing position by 60%, while reducing my average cost basis by nearly 11% towards $745. Sure it could drop below $600, but again, my goal is to improve cost basis by greater than 10% as a minimum standard.
I am shocked to see Shopify at today's level. But I don't have time to be shocked, only time to focus on managing the portfolio and adjusting strategies to optimally execute during times of extreme volatility and pressure.