Shopify (SHOP) stock has been on a tear since releasing stellar Q3 results. Shares broke out of their year-long range, fueled by impressive numbers across the board. More importantly, despite its extended post-earnings rally, Shopify’s Q3 report revealed three key catalysts – accelerating growth, expanding free cash flow margins, and declining stock-based compensation – that could continue to fuel the bullish sentiment driving the stock and lead to further gains. Consequently, I am bullish on SHOP stock.
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Catalyst #1: Accelerating Revenue Growth
The first reason I believe Shopify’s bullish momentum will stay strong is its accelerating revenue growth – a rather impressive feat for a company at this stage of maturity. Specifically, Shopify’s revenues advanced by 26.1% year-over-year to $2.2 billion in Q3. This marked SHOP’s sixth consecutive quarter of revenue growth above 25%, excluding its recently divested logistics division. Notably, this result reflected an acceleration from last quarter’s 20.7% growth and the 25.5% growth recorded a year earlier.
Several factors contributed to such a fabulous top-line performance. Shopify’s Gross Merchandise Volume (GMV) climbed 24%, reaching $69.7 billion. At the same time, the adoption of Shop Pay continued to gain traction, making up 62% of GMV, up from 58% last year. I think this demonstrates that Shopify’s payment ecosystem delivers significant value to merchants, who are willing to pay its relatively high fees (typically 2.9% + $0.30 per online transaction) for the frictionless payment experience it provides. In turn, Shopify generates substantial, high-margin revenues.
Offline retail was another significant growth contributor, with Shopify’s expansion of Tap to Pay and its overall point-of-sale improvements driving merchant adoption higher. Growth among merchant solutions and subscription services also rounded out the quarter’s top-line gains, once again showing that Shopify’s all-in-one approach to help merchants succeed across all channels is paying off handsomely.
Catalyst #2: Expanding Free Cash Flow Margins
The second catalyst likely to keep fueling Shopify’s bullish outlook is its consistent expansion of free cash flow margins. In particular, Shopify’s free cash flow margin climbed to 19% in Q3, a notable improvement from 16% in the same quarter of the previous year. This expansion, combined with solid revenue growth, led to a surge in free cash flow, which increased 53% year-over-year to $421 million. Here, we see the company’s focus on balancing growth with operational efficiency, which continues to bear fruit quarter after quarter, as management has emphasized disciplined spending and careful allocation of resources.
Key drivers behind Shopify’s improved cash flow efficiency include lower-than-expected marketing spend and a steady approach to headcount expansion. The company has effectively managed costs, particularly in non-performance marketing, while supporting its enterprise and point-of-sale initiatives. By keeping operating expenses well below revenue growth rates, which grew by a much lesser 7.2% in Q3, Shopify can easily achieve tremendous leverage to expand its margins.
Catalyst #3: Easing Stock-Based Compensation
Lastly, Shopify’s easing stock-based compensation (SBC) might persuade skeptics to finally consider investing in the stock. Year-over-year, SBC grew only marginally in the quarter, leading to a significant decline in SBC as a percentage of revenue. In fact, Last-Twelve-Month (LTM) SBC, as a percentage of revenues, hit a mere 5.1%.
Note that many investors have long been cautious of Shopify’s high SBC levels, a factor that has been a point of argument and a reason for some to avoid the stock. Given that this latest trend seems to suggest that Shopify is addressing these concerns head-on, I believe that it could potentially bring new investors into the fold who were previously cautious about the risk of continued dilution. This, therefore, could prove another vibrant catalyst for the stock’s ongoing bullish momentum.
What About the Valuation?
Despite these three strong catalysts that could sustain Shopify’s bullish momentum, it is worth noting that the stock’s valuation remains steep. Currently trading at 83 times this year’s expected EPS, the stock is undeniably richly valued. However, given the company’s impressive track record of delivering consistent revenue growth above 25% and ongoing margin expansion, there is a strong argument that Shopify will be able to grow comfortably into its valuation. With accelerating growth in Q3, expanded free cash flow margins, and disciplined cost management, I do believe that this argument indeed holds up.
Is SHOP Stock a Buy?
Wall Street’s outlook on Shopify seems somewhat more cautious following its extended gains. The stock currently holds a Moderate Buy consensus rating, with 11 analysts recommending a Buy, six a Hold, and one a Sell over the past three months. Still, Wall Street’s average SHOP stock price target of $85.31 suggests a potential downside risk of 21.37%.
If you’re wondering which analyst you should follow if you want to buy and sell SHOP stock, check out Richard Tse from National Bank. He is the most profitable analyst covering the stock (on a one-year timeframe), boasting an average return of 84.19% per rating and an 82% success rate.
Takeaway
Summing up, Shopify’s Q3 results revealed three key catalysts – accelerating revenue growth, expanding free cash flow margins, and easing stock-based compensation – that position the company for sustained bullish momentum. Undoubtedly, its valuation is steep following Shopify’s explosive post-earnings share price surge. Still, I believe that Shopify’s consistent growth and disciplined cost management provide a compelling case for its premium. This is particularly true given its market-leading position and overall moat. For this reason, I remain bullish on SHOP stock.
