Despite elevated valuation multiples, Shopify (TSX: SHOP) may not be as expensive as it appears when considering its growth potential and leadership in artificial intelligence (AI). Even with a high price-to-earnings (P/E) ratio, if investors believe in the AI narrative presented by management, the current valuation fails to fully reflect long-term earnings growth potential, making Shopify a significantly undervalued stock.
This is a common trait among growth stocks: using rapid growth to justify high valuations.
In fact, some expansion in valuation multiples is expected before an anticipated compression, though the extent remains uncertain. Regardless, the focus should be on evaluating the company’s growth narrative and assessing the certainty of its profit growth. Having a compelling growth story is one thing, but executing effectively to turn that story into reality is another.
The core question in the current market is whether AI investments (some spending from the “Mag Seven” has gotten slightly out of hand) will enhance corporate profits (sales and margins) at a rate acceptable to investors. If massive investments yield only minimal returns, investors are likely to become dissatisfied and trigger sell-offs, potentially leading to a market correction or a minor bubble burst. However, bulls argue that AI has not yet reached full-blown bubble territory, though overvaluation and hype exist, which could pave the way for a mild bear market similar to the one in 2022.
Shopify’s Q2 earnings report, released earlier this month, exceeded analysts’ expectations in both revenue and profit. The company posted revenue of $2.68 billion, with adjusted earnings per share of $0.35, while gross merchandise volume (GMV) grew 30.6% year-over-year to $87.8 billion. Additionally, through disciplined headcount management and operational leverage, the company reduced its operating expense ratio from 42% in the same period last year to 38%, maintaining a double-digit free cash flow margin for the eighth consecutive quarter.
The strong quarterly performance prompted management to issue optimistic guidance for Q3, further boosting investor confidence. Since the earnings release, Shopify’s stock price has risen by 10.2%, though it still trades at a 10.5% discount to its 52-week high.
Looking ahead, Shopify is actively investing in AI, having already launched several AI-driven tools such as Shopify Catalog, Universal Cart, Checkout Kit, and Sidekick, which are expected to expand its customer base and drive GMV growth. The recent acquisition of Molly Studio is also poised to enhance its AI and design capabilities. Overall, Shopify’s AI strategy is commendable and is projected to translate into tangible earnings growth over the next three years.
Year-to-date, Shopify’s stock has gained 26.2%, outperforming the broader market. However, its forward price-to-sales and price-to-earnings ratios have risen to 14.7x and 89.5x, respectively. Despite its premium valuation, the market remains willing to pay a premium for its growth potential.
Historical performance has shown that Shopify, while appearing expensive, may actually be cheap—a paradox rooted in the compelling AI narrative advanced by its top-tier management. The company’s leaders not only understand AI technology but also excel in applying it effectively, a differentiating advantage that could serve as a critical competitive barrier. The next phase of the AI race will not be determined by which models are used but by how intelligently they are deployed. In this context, Shopify stands out as a clear winner, fully deserving of its high P/E ratio.
