After years of rapid expansion, the jury is now out on Shopify (SHOP 0.67%) stock. The e-commerce software giant is making a push into recent areas to advance digital commerce for small businesses and entrepreneurs, but that is costing loads of money — not to say diluting existing shareholders with stock-based compensation. Amidst the mess, Wall Street has punished this former market darling. Shares are down greater than 80% from all-time highs reached in late 2021.
But how profitable is Shopify exactly? And is there an efficient option to track its progress in delivering returns to investors? Yes, there may be. Let’s dig in.
Free money flow is back on shaky ground
The last I wrote about Shopify following the second-quarter report, I discussed what accounted for the corporate’s massive $2.68 billion net loss (using GAAP, or generally accepted accounting principles) through the primary half of 2022. In a nutshell, the issue is the corporate’s investments in Affirm Holdings and Global-E Online, which have each taken successful and reversed their massive gains from 2021.
But that only tells a part of the story, since declines within the stock market are listed as a non-cash expense. GAAP net income or net loss doesn’t really tell the true profitability of Shopify’s actual operations. That is where free money flow is available in. Free money flow is income from operations less capital expenditures (money spent on property and equipment).
During the last 12 months, Shopify has generated $58.8 million in free money flow. This includes negative $206.2 million in free money flow in the course of the first half of 2022. It is not a $2.68 billion net loss, but negative $206 million is not great either.
It is a newer trend for Shopify, because it began to succeed in some respectable free-cash-flow margins in 2020 and 2021 as e-commerce activity boomed early within the pandemic. But hastily, that trend has dramatically reversed course. For an organization that has hauled in $5 billion in revenue during the last 12 months, why is it now operating within the red on a free-cash-flow basis?
The gears of innovation are grinding forward
With many effects of the pandemic winding down this 12 months (namely people doing most of their shopping online versus in person), Shopify was at a crossroads. It could have sat back and enjoyed the small empire it had built and began specializing in profitability. Or it could follow the playbook Amazon established over the 2000s and 2010s: Spend free money flow, at times nearly all of it, to advertise more expansion. Shopify has chosen option two.
Sales and marketing expenses are up 62% through the primary half of this 12 months, and research and development is up 81%. With revenue growth slowing to only a 19% pace, this big advance in operating expenses is weighing down profitability. Shopify justifies this spending, since it sees a lot of opportunity to deepen its relationship with merchants with recent services. It is also gearing up for an enormous push into logistics and order achievement with the buildout of Shopify Success Network (which can ramp up next 12 months) and the acquisition of Deliverr.
Included in these expenses is a lot of stock-based compensation paid to employees, which dilutes ownership of existing shareholders. Stock-based compensation has totaled $257 million thus far in 2022, or about 0.7% of the corporate’s current market capitalization.
With free money flow headed toward negative territory for full-year 2022, how can shareholders track growth progress while also factoring in stock-based compensation? Use revenue per share. Even when accounting for all that stock issued to employees over time, Shopify’s returns using this metric have been impressive. And up until this 12 months, free money flow per share growth was impressive too.
In fact, none of it will matter if the corporate doesn’t eventually start turning a profit again. For the following couple of years, heavy spending to advertise recent services and the development of its order achievement business will likely keep a lid on free money flow. With investors punishing loss-generating businesses without delay, Shopify stock can have difficulty gaining positive traction. But when the corporate can reignite its revenue growth, there’s still a lot of value to be unlocked here over the long run. Patience shall be needed, though.
John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Idiot’s board of directors. Nicholas Rossolillo and his clients have positions in Amazon and Shopify. The Motley Idiot has positions in and recommends Affirm Holdings, Inc., Amazon, Global-e Online Ltd., and Shopify. The Motley Idiot recommends the next options: long January 2023 $1,140 calls on Shopify and short January 2023 $1,160 calls on Shopify. The Motley Idiot has a disclosure policy.