Before We Start
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About This Valuation
This is going to be a very simple, fast and dirty valuation.
I’ll be rounding things up because I don’t want to use a calculator. As well, I’d rather be roughly right, than precisely wrong. Valuation is an inexact art.
I’ll be using a 1-stage DCF, also known as the “Bond Perpetuity Formula”.
Like any valuation, it’s only as good as it’s assumptions, and it’s difficult to predict the future.
Anyways, let’s proceed.
Let’s look at the balance sheet
Total assets are about $12B
Total liabilities are about $2B
Cash on hand is $7B.
Shareholder equity AKA book value is $10B.
Put another way, if I pay off my debts, I have $10B in assets.
Let’s look at the income statement
Their 3 year revenue history was $1.6B, $2.9B and $4.6B.
I’ll just assume their revenue will be $4B on average if they don’t grow to be conservative.
Their 3 year Free Cashflow was $500M, $400M, and $14M
But, we need to check their gross margin — it looks to be about 50%+.
So 50% on $4B would be more like $2B in Free Cashflow that we just aren’t seeing because it’s being reinvested.
To be conservative, let’s call it $1.5B to give ourselves a bit of room.
Shopify Valuation — First Pass
To keep things simple, let’s assume we think Shopify has a moat.
Let’s also assume we think they will continue earning $1.5B a year in free cashflow, into the distant future.
How much should we pay for $1.5B of free cashflow?
Well, if we want a 10% return on capital, we should pay $1.5 / .10 = $15B
But Shopify also has $10B of assets, so we should pay $15B + $10B = $25B.
Now, if you want to be a bit more aggressive, we could take the full $2B of free cashflow.
$2 / .10 = $20B
But Shopify also has $10B of assets, so we should pay $20B + $10B = $30B.
If I wanted to be conservative, I would demand a 15% return, and I would use the $1.5B. Being conservative is better, so this is the valuation I recommend:
$1.5 / .15 = $10B in Free Cashflow + $10B in assets = $20B
So, we now have a range of values.
$15–30B if Shopify doesn’t grow.
Checking My Facts
At this point, if I were going deep, I would check my assumptions
- Does Shopify have a moat that will protect that $1.5–2B in Free Cashflow?
- What is the source of their competitive advantage?
- Are gross margins really 50%+?
- Is Shopify wisely investing the $1-$1.5B not showing in Free Cashflow?
- Are Shopify’s assets really worth $10B? What is their liquidation and reproduction value?
Like I said, this is the quick and dirty version, so that is your homework to do.
Factoring in the growth
Value investors use growth as a margin of safety.
Average revenue growth was 47%, 86% and 57%.
Call it about 60% average growth.
Let’s guess at what growth might be:
Growth might be 0% in the worst case, and it might be 60% in the best case.
I’d call it 20 or 30% just to be safe.
The key here is to admit you don’t know and cannot know.
The growth is somewhere between 0% and 60%.
But for how long? How sure are you?
Basic Valuation
I’d pay a maximum of $30B for the business, and let the growth be my margin of safety.
Up until now, I haven’t looked at the market cap, so let’s take a look.
The market cap is $65B as of May 15, 2022.
What I like to do now, is reverse engineer the market’s expectations, based on current prices.
Let’s do it.
Market expectations on Shopify
I assume I have $10B in net assets, so I can knock that off the market cap.
The true market cap then is $55B.
Let’s assume we get $2B in no-growth free cashflow from Shopify into the distant future
If I pay $55B and I get $2B a year, then the formula is 2/55 = 3.6% ROI
That means I get a 3.6% ROI at current prices.
Remember, Warren Buffett says that “price is what you pay, value is what you get”. While intrinsic value matters, thinking about your return on investment is also critical.
Ultimately, I am paying $55B to get all of Shopify. I get 3.6% returns if there is no growth and the revenue and free cashflow continues.
Modelling my return with growth:
Investors need to make a good return — typically they want to beat the market average of 9% — so let’s call it 10%.
I think investors are buying now, because if Shopify only grows at 6.4% a year (and remember they’ve been growing at 60%), then they will achieve their target of beating 9%.
My take on the value of Shopify
Value investors will pay full price for a stock if that company is growing, and they will use growth as their margin of safety.
For me, I think 10% is the minimum a person should make from investing in the markets.
So Shopify would be a buy at $2/.10 = $20B + $10B = $30B market cap.
Then you’d get the growth for free.
What Current Prices Indicate
You could still win buying Shopify if they continue to grow at 60% year after year. The problem for me as an investor is, I don’t know how much they will grow, and for how long. Value investors can’t predict growth, so they can’t bet on it.
However, I could pay “full price” for the business and get the growth for free. But right now, if I pay full-price I only make 3% yields.
For me, Shopify would be a “buy” if it was trading closer to $30B.
I might even pay $35–40B if I was extremely bullish on the growth story.
But at today’s prices, there isn’t much room for error.
In Summary, it all depends on what kind of investor you are
It’s a buy if you believe in long-term, sustainable growth above 20%.
If it grows at 60%, and you buy it at todays price, your yield will be 63%.
That’s pretty incredible.
Even if it grows at 20%, your yield is 23%.
So if you are open to take that risk, the stock is a buy.
It’s not a buy if you demand a 10% yield at today’s prices and use growth as a margin of safety.
As you can see… I can’t give you the “exact intrinsic value” because that depends on the future. We can expect though that the company will grow somewhere between 0% and 60% in the next year. The hard part is predicting what their growth will be far into the future.
For that reason, I wouldn’t personally buy it until it’s closer to $30B and I feel it is still overpriced.
Ultimately, it’s an interesting example of valuation because it really highlights the concept of margin of safety and your risk tolerance.
I do believe Shopify is a great company, and I do expect them to grow, but it would be more of a bet or a speculation for me personally than an investment.
One Last Question
One other question I like to ask, is how much can I lose if things go badly?
As I mentioned earlier, market cap is $65B as of May 15, 2022.
The cash covers the debt, which I like ($7B cash and $2B debt = $5B net cash).
There are some assets there as well — so $10B of net assets.
What if cashflow declined to $1B? The company would be worth $20B ($10B Free cashflow + $10B assets).
Since its at $65B, I think I could lose the spread — $40B, around 60%.
If it was $30B, the spread would be $10B, or 33% loss.
Asymmetric Bets
It would be amazing if I could buy Shopify at $20B, because I would be unlikely to lose much, but my upside could potentially be 60% returns.
At $65B, I could lose quite a bit, maybe 60%, and I could make 60%. So my win/loss ratio is about equal.
As an investor, I’m looking for mispriced bets.
This is a great company, selling at a fair price, but it’s not asymmetric.
Summary:
Shopify could still be a buy, even at today’s high prices — but you really need to believe in their growth story, moat and management. If you believe they can sustain even 30% YoY growth over the next 10 years — it’s a buy. Just be aware that if you are wrong, there isn’t a huge margin of safety.
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