Why Shopify Stock Popped 16% in August

Key Points

• The stock gave back some gains on concerns about valuation.

• While the stock looks fully valued, it can move higher through growth in the underlying business.

• 10 stocks we like better than Shopify ›

Shares of Shopify (NASDAQ: SHOP) were climbing the charts last month after the e-commerce software superstar turned in strong results in its second-quarter earnings report. It also benefited from an improving outlook for interest rate cuts, which should help Shopify as a growth stock and one that relies on small businesses that benefit from cheap capital.

Additionally, several Wall Street analysts weighed in on the stock with price target hikes. By the end of the month, Shopify had gained 16%, according to data from S&P Global Market Intelligence.

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As you can see from the chart below, Shopify stock actually pulled back following the post-earnings surge, due in part to its concerns about its valuation.

Image source: Getty Images.

Shopify shines again

Shopify struggled in the aftermath of the pandemic and with a botched expansion into logistics through the Deliverr acquisition. But it delivered another quarter of strong growth on the top and bottom lines, showing those days are long behind it.

Revenue in the quarter jumped 31% to $2.68 billion, ahead of the consensus at $2.55 billion, while gross merchandise volume was up by the same percentage to $87.8 billion.

Margins were also solid, with a free-cash-flow margin of 16% and adjusted earnings per share of $0.35, which topped estimates at $0.29.

Shopify jumped 22% on the day of the report, showing investors were clearly impressed with the results, but shares pulled back over much of the rest of the month on valuation concerns. Shopify now trades for a price-to-sales ratio of 19 and a price-to-earnings ratio of 81, valuations that typically apply to smaller companies, though Shopify is still growing rapidly.

One analyst, Phillip Securities, downgraded the stock to neutral but raised its price target to $150 in regards to a valuation that appears "stretched."

What's next for Shopify

Shopify's guidance was strong as well, calling for a revenue growth in the mid- to high-20% range for the third quarter, and a similar free-cash-flow margin to Q2, showing it expects its momentum to continue.

Overall, the business is in great shape. Its merchant base continues to grow. It's finding new ways to monetize it, and it's delivering solid profit growth.

Still, the valuation concerns are valid. At this point, investors shouldn't expect much multiple expansion from the stock. For the stock to move higher, it will have to do so by growing its revenue and earnings, though it's plenty capable of doing that.

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Jeremy Bowman has positions in Shopify. The Motley Fool has positions in and recommends Shopify. The Motley Fool has a disclosure policy.