The Cautionary Tale of Shopify: Or Why Some Previously Hot Comapnies May Not Bounce Anytime Soon.

We all know that high inflation and a shifting rate environment have punished certain stocks extremely. With some names down 70-80%+ it is not surprising that some investors are starting to view them as "cheap" or even "bargains."

Is this true? Is the time now? Is this the ultimate "buy the dip opportunity??" Especially if you are willing and able to be a long term investor?

No.

These companies can just as easily become value traps as good value.

What is a value trap?

It is a stock that looks cheap based on its fundamental data; however, it might be cheap for a reason! If a company is cheap on various fundamental metrics it may be because it is disappointing in terms of its earnings projections.

But guess what? It can keep doing so!

Let us take the cautionary case of the (excellent) e-commerce company, Shopify.

You might have missed it during the endless hand wringing and depressing focus on inflation but the Canadian enterprise had another brutal week.

  • The stock declined by over 10% this week which puts Shopify down around 80% for the year.

That is quite a plunge for a company that was a market darling all of 9-10 months ago. At its peak the company had a market capitalization of over $220 billion. On Friday it was down around $40 billion. The e-commerce wunderkind soared during the pandemic as many businesses opened online or saw more and more of their custom move there. This led to not only high expectations of future growth but unrealistic ideas about how sustainable the past growth actually was.

Put differently, Shopify was priced for where the pandemic behavior would never end. That it would become the new normal. The expectation was that the rapid shift to online retail would not only continue, but also be a permanent period of exponential growth.

But the pandemic was the farthest thing from normal!

Since then, the plight of Shopify underlines two problems that are common throughout a lot of "must have" stocks that are now, somehow, "avoid at all costs."

  1. The first is that Shopify is trying a lot of things but failing to recapture growth momentum.

  2. The second is that in doing so it is spending a lot of capital and, like many other fallen growth stars, loses money on a quarterly basis which presents the company with a larger problem - capital is both finite and becoming more expensive by the quarter.

Combined, both of these issues suggest that, despite appearing very cheap relative to recent history, Shopify is still not cheap enough. Without growth, a former growth stock can fall a long way.

This isn't all that uncommon. Typically, every year around 30% of the MSCI value index - an index of supposedly "cheap" value driven companies - underperforms that index by 9-10%.

Recapturing your previous momentum is difficult. Not that Shopify isn't trying however. Here is what Shopify has done in the last few months:

  • split its stock.

  • extended its joint partnership with buy-now-pay-later (and another fallen pandemic star) Affirm

  • partnered with Twitter

  • moved into business-to-business sales

  • made a bunch of acquisitions.

The challenge is that none of these maneuvers will likely re-galvanize consumer buying behavior back to peak Covid norms. It is commendable that they are trying and certainly one can hope that over the very long term some of these investments and decisions will pay off handsomely.

But in the immediate future these efforts have consequences. Most especially, nearly all of these developments also spend money, and Shopify loses money already. You might be buying back into a company that will need to dilute its shareholders by issuing new equity, in the months ahead, trying to rediscover the old magic that was largely the domain of exceptional circumstances.

That could happen. But when the positive case is we might avoid a recession in the next year or two that seems like quite a risk.

And Shopify is hardly alone. Affirm. Zoom. Doordash the list goes on and on, even Amazon.

And speaking of Amazon, that might be the biggest threat to Shopify of all.

The Seattle giant is also struggling to maintain its post pandemic growth momentum which likely means it will look for new business lines to enter and cannibalize. Shopify's online selling tools make for a ripe target.

Before buying a great company like Shopify (and it is a great company!) ask yourself what you are really buying? Is it yesterday's story or tomorrow's cautionary tale?

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