Is it time to buy the drop in Shopify stock?

E-commerce software company stock price volatility Shopify (shop -3.21%) It attacked me again. Investors appear to be concerned about two things. One is a slowdown in projected revenue growth for the spring quarter of 2024, and the other is the company's inability to maintain net income based on generally accepted accounting principles (GAAP).

But on the surface, Shopify could be a good candidate to buy on the cheap. Here's why:

Profiting from a long-term perspective

As a reminder, Shopify offers two main products: Subscription Solutions (basic website design and management software tools) and Merchant Solutions (value-added services such as digital payment acceptance and delivery). We report our business by segment.

Last year, Shopify sold its low-margin logistics and warehousing division (formerly part of its Merchant Solutions division), which put a slight drag on its reported year-over-year sales growth. ing.

Data source: Shopify.

With Shopify refocusing on profitable software, much of the investor focus has shifted to revenue. And in this sector, Shopify continues to cause some shareholders anxiety. That's because the net income that was developing in 2023 has shifted to net income. loss In the first quarter of 2024.

Data by YCharts.

Again, as I've discussed many times over the last year, GAAP net income is a very tricky metric to measure Shopify's financial performance at this point.

First, Shopify has a significant stake in its e-commerce software partners, so its quarterly price-to-earnings ratio has a large impact on its net income and loss. Global E-Online (NASDAQ:GLBE), Affirm Holdings (NASDAQ:AFRM)and Claviyo (NYSE:KVYO). As of the end of March 2024, these holdings were worth $1.89 billion, down from $2.23 billion three months earlier. This is because all three stocks performed poorly in the first quarter.

Data by YCharts.

In contrast, GAAP operating income (excluding quarterly unrealized investment gains and losses and some interest income from the $5.18 billion in cash and short-term investments that Shopify held) actually came in at $86 million. It generated a small profit of USD. Off in 2024.

Is the valuation still “cheap”?

Now, moving on to free cash flow (FCF) metrics, which give a better picture of where Shopify is currently at, especially now that its logistics business is gone: Management proudly announced FCF of $232 million and an FCF margin of 12%, double the 6% forecast in Q1 2023.

For a software company, a 12% FCF margin is very low. A healthy margin would be at least 20%. However, there is still significant room for improvement in the coming years as the business matures. The company remains a company very interested in growth.

And it's growing. Investors were also a little concerned about his second-quarter outlook for revenue growth to remain in the low 20s (excluding the impact of the unloading logistics business), which remains solid. This is a prediction. If Shopify can further increase its FCF margin this year (say, around 15%), it expects to generate $8.5 billion in revenue and $1.3 billion in FCF this year.

To be clear, Shopify is valued at about 77x this year's projected FCF (my estimate). That's not cheap by traditional standards, but I position Shopify as a relatively young software company with the potential to grow revenues by 20% over the next few years. If margins continue to improve going forward, that's even better.

Perhaps Shopify isn't the most timely buy right now, despite the dip after its first-quarter earnings release.Other e-commerce stocks, e.g. Amazon (Nasdaq:AMZN)has achieved improved profitability. That said, I'm happy to continue owning Shopify stock given its steady progress.