Shopify Stock Has Become a Bubble

This article was originally published on this site

Shopify (NYSE:SHOP) stock has plateaued. SHOP had  a massive run-up, as Shopify stock more than tripled in eight months. However, SHOP stock pulled back dramatically in August and has traded in a range since that time.

Source: justplay1412 / Shutterstock.com

Now many wonder what SHOP stock will do next. Will it retest its all-time high of $409.61 per share or will it resume its decline?

Imagine the Unimaginable

Shopify stock is a long-term winner. However, the owners of SHOP stock have a lot to worry about in both the short and the medium term.  InvestorPlace contributor Luke Lango, a SHOP bull, described the recent 23% decline since August as a normal, healthy pullback. Stocks that are in a longer-term rally commonly undergo such declines, and he may well be correct.

However, the behavior of SHOP stock could also serve as a reminder that the “unimaginable” routinely occurs in the stock market. Unfortunately, SHOP stock is poised for a massive drop if investors’ sentiment turns negative.

Shopify stock still trades at 330 times its  forward earnings. At that level, it would have to fall almost 90% from its all-time high before it would no longer be overvalued by traditional standards.

But such drops happen even to even to solid companies. In September of last year, many thought Nvidia (NASDAQ:NVDA) could do no wrong as NVDA stock climbed north of $290 per share. I can also remember when people thought the same about Cisco (NASDAQ:CSCO). At one point in early 2000, CSCO rose above $80 per share, briefly becoming the world’s most valuable stock.

However, NVDA stock lost about 60% in less than three months last year. Cisco would go on to lose 90% of its value over two years as the tech boom went bust. Nearly 20 years later, CSCO stock has not yet regained its all-time high.

Competitors, Economy Could Hurt Shopify

But is it possible that those who are bullish on SHOP stock will be proven correct? Of course. The unimaginable happens every day. InvestorPlace contributor and Shopify stock bull Nicolas Chahine predicts that, “the breakout in either direction will be strong.” I agree with his assertion.

Still, many signs indicate that SHOP stock cannot continue to trade at such high valuations. Unlike some other stocks that have broken out to the same extent, Shopify has competition. WordPress developers tend to gravitate toward WooCommerce. Adobe’s (NASDAQ:ADBE) purchase of Magento has made ADBE a competitor of SHOP.

Furthermore, if a recession occurs, it will probably hit the small and medium-sized business that Shopify serves will be especially hard-hit. Shopify could attract new business as unemployed workers scramble for a way to earn money. However, that turnover will create uncertainty that could lead investors to question the high valuation of SHOP stock.

How to Trade SHOP Stock

SHOP stock could move back to its record high or even beyond.

But Shopify stock looks like a bubble. Virtually no company can justify a 330 forward price-earnings ratio, regardless of  its performance. Investors also need to remember that even the seemingly most solid of companies can lose almost all of their value.

Despite the high price of Shopify stock, I see SHOP as a long-term winner.  Even with the rising competition in the e-commerce space, businesses often choose SHOP when they want an e-commerce platform that’s not tied to Amazon or other large tech firms. Although a recession could disrupt the company’s growth for awhile, its business has just scratched the surface of its potential, given the explosive outlook of e-commerce. Shopify will benefit as more businesses utilize e-commerce.

Unfortunately, in light of the sky-high valuation of SHOP stock, investors do not know whether these catalysts will boost SHOP stock within several days or several years. That makes SHOP too risky to buy at its current levels.

As of this writing, Will Healy did not hold a position in any of the aforementioned stocks. You can follow Will on Twitter at @HealyWriting.