The recent rise in Shopify stock is not a sign to buy
Since the end of July, Shopify (NYSE:SHOP) the stock has trended higher. With this gain, you might think that SHOP stock has bottomed out and is poised for a real rally. Still, far from the beginning of the recovery, what happens to the stake in the e-commerce software company can best be described as “The dead cat returns.”
In other words, it experienced a temporary rally higher after an extended pullback. Furthermore, this dead cat news is the product of an external factor rather than news related to the company. On top of that, the positive impact of this external factor has begun to wane.
Market conditions are once again developing unfavorable. With the company’s problems far from resolved, investors can forget about the ensuing rally. A move to new lows is still possible. Ignoring the SHOP inventory continues to be your best move.
SHOP Stock and its ‘Dead Cat’
As I discussed in my last Shopify post, yes company related news that gave it a brief boost in July. This latest gain, however, is due to something more market-related: increasing hopes that Federal Reserve will cut interest rates next year.
Given the growing recession risk, investors temporarily believe this will happen. A rate cut next year, after raising rates this year to tackle inflation, should soften the blow of the recession. It will also be a positive for stocks, especially growth stocks like SHOP. The sharp increase in interest rates has played a role in this stock’s sharp year-to-date (YTD) drop.
Unfortunately, the latest macro data has dampened confidence that a rate cut is just around the corner. Last week’s strong jobs report suggested the Fed could raise rates further without sending unemployment soaring.
If this week’s Consumer Price Index (CPI) numbers suggest that inflation is getting worse, markets will take that as a sign that the Fed will continue with its hawkish fiscal policy. While market conditions are turning unfavorable once again, difficulties also affecting its performance continue to linger.
There is still a significant downside risk
A high CPI will signal that the Fed will not slow down the pace of rate hikes. Just as lower ratios are good for growth stocks, higher ratios are bad for them. Higher interest rates reduce the present value of future income. That’s bad news for the SHOP’s well-priced inventory. It continues to trade at a high valuation.
At current prices, Shopify trades for an estimated 417.2 times earnings in 2023. The stock has been susceptible to a downgrade, independent of external factors like interest rates. One could argue that its current valuation would be justified, if it continued to rise at 57% annual clips (same as last year).
But based on its latest financials, today’s valuation makes no sense. Increase the revenue the previous quarter was only 16%. Slowing growth, coupled with rising costs, led to an adjusted quarterly loss of 3 cents per share. Analysts expected earnings of 3 cents per share.
Worse, improved outcomes are more likely to occur later than earlier. The company itself has admitted this, citing that factors such as high inflation and rising interest rates will continue to put pressure on consumers. Already expensive based on expectations that Shopify may not live up to, more frustration and downside risk.
Given my negative opinion of Shopify, it’s no surprise that it continues to receive an F rating in Portfolio Scoring Machine. As recently as a year ago, the company had a lot going for it. E-commerce growth remains strong, even as the headwinds of the pandemic are fading. It is still in high growth mode. With the market at the moment having a “grow at all costs” mindset, it seems unlikely to sink.
Now, the script has been flipped. The economic downturn is severely affecting demand for the country’s services. Growth is faltering and the company is reporting a net loss. Higher interest rates have resulted in growth stocks falling out of favor.
Despite falling nearly 78% from its all-time high, there’s plenty to indicate that SHOP stock is experiencing another material drop. With this in mind, don’t view her recently deceased cat’s return as an invitation to buy.
Originally published on Investorplace. Read here.
Featured image credit: Mali Maeder; Bark; Thank you!