• Tue. Nov 29th, 2022

2 Mistakes Shopify Needs to Fix

BySamuel M. Craig

Aug 9, 2022

Shopify (NYSE: SHOP) has had a great story of growth over the years. From less than $1.1 billion in revenue in 2018, the tech company more than quadrupled that figure, hitting $4.6 billion last year. However, for investors, the focus is now on its slowing growth rate and the challenges ahead for the company. Shopify shares are down 70% this year (compared to just 13% losses for the S&P500) in what seems like an endless free fall.

There are two particular mistakes the company has made in recent years that are causing misery for its investors these days.

Shopify was too focused on growth and overlooked costs

One of the things I always questioned about growing the tech company was all the different avenues it was pursuing. It has a powerful e-commerce platform that allows anyone to become a trader and easily integrate with a website. But building on that success wasn’t enough – in 2019, for example, he went on a tangent and launched Shopify Studios, which is for film and TV production.

In 2020, it also announced plans to spend $1 billion to build a distribution network across the United States that would put it on a collision course with the online retail giant. Amazon, threatening to entice its merchants. It’s a risky (and costly) decision. Last month, it continued that strategy with the completion of its $2.1 billion acquisition of fulfillment technology company Deliverr, as it aims to provide Shopify merchants with an easy-to-use logistics platform.

The problem with this is that Shopify probably should have been a bit more conservative with these expansion efforts because its operations aren’t always profitable and margins are generally slim at best. Compared to other platforms, it just doesn’t generate solid numbers.

Data by YCharts.

Too much focus on growth at a time when the business is still struggling with profitability can only exacerbate business problems. In July, the company announced that it would lay off 10% of its staff. However, more drastic cost reductions may be needed to improve its margins.

The company was too optimistic about its future

One of the startling admissions when the layoffs were announced was that Shopify CEO Tobi Lütke admitted that he was wrong to predict that trends stemming from the pandemic would become permanent. In the press release announcing the layoffs, Shopify said, “We’re betting the channel mix — the share of dollars flowing through e-commerce rather than brick-and-mortar retail — would jump five-fifths permanently, even 10 years.”

This rosy outlook has led the company to hire overly specialized and duplicate roles. Shopify also admits it had groups that were “convenient to have but too far removed from building products”. Essentially, the company allowed itself to be inflated by personnel and expenses on an extremely optimistic forecast.

It’s a rude awakening for a company that thought it could get away with relentless spending because the growth was there. When growth slowed (sales only increased 16% in the second quarter), everything came to a screeching halt.

Adding a little conservatism to future forecasting and planning could save the company a lot of headaches in the future. It would also prevent the company from adding overhead and headcount that it doesn’t really need.

Has Shopify fallen low enough to be worth investing in?

Shopify is trading around levels last seen in 2019. It’s still not a cheap stock – with a price-to-sales multiple of 10, it’s more expensive than Etsy (seven times sales) and well above Amazon, eBayand Wix (each about three times the sales). It has generally traded at a premium to these stocks in the past, but the big question mark is whether it still deserves that significant premium.

However, with the company focusing more on cost management and improving operations, it could still be a good buy at its beaten price. Shopify has the ability to come out stronger if it learns from its recent mistakes. If you’re a long-term investor, buying Shopify now might be a good decision. There is already plenty of bearish in the growth stock, making it an attractive contrarian buy.

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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a board member of The Motley Fool. David Jagielski has no position in any of the stocks mentioned. The Motley Fool holds positions and recommends Amazon, Etsy, Shopify and Wix.com. The Motley Fool recommends eBay and recommends the following options: $1140 Long Calls in January 2023 on Shopify, $1160 Short Calls in January 2023 on Shopify, and $50 Short Calls in October 2022 on eBay. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.