March trades

The last few weeks following the immediate aftermath of the Russian invasion of Ukraine have actually been very good for the stock market. My portfolio has had a significant rebound but not enough to rescue my performance from a dismal start to the year – more on that in my upcoming portfolio review.

While things looking more positive for stocks at the moment, there are still dark clouds on the horizon. A possible upcoming recession, driven by major cost shocks from Russia Ukraine conflict exacerbating the existing supply chain issues, seems to be becoming more of a concern than an overheating economy now. This should actually have some benefits for quality growth stocks (at least in short term) if it relieves some of the demand for tighter interest rates.

With these developments in mind, I have been rebalancing away from stocks more exposed to a weaker consumer environment and adding to those in more defensive sectors. With that in mind I sold JD, Liontrust Asset Management and S&U near the beginning of the month. I also sold Gamma Communications after its last results were underwhelming 1 not a disaster but growth does look more difficult from here. This was a situation where in hindsight I held on for too long in spite of the declining relative momentum. I sold the bulk of my holding before it fell too far, at least making some profit, but I gave back a lot more than I should have.

I decided to buy a gold producer etf. Given the high degree of macroeconomic uncertainty at the moment, some diversification in this direction seems like a good idea. I don’t have a lot of confidence in my ability to time commodity cycles but it does seem like conditions in the near term may favour gold ie inflation, war, recession risks and possibly fewer interest rate rises on the horizon than the market is currently expecting.

I decided to buy Adyen back. My previous sale seemed to be an error given the strength of its last results but wider market weakness has given me a chance to buy it back at a similar price. I also bought Shopify. I have been a big fan of the business but the valuation has seemed prohibitively expensive for some time. So when the price hit $500 this seemed like a good point to start dipping my toe – as it happens this was the short term low which was quite satisfying.

Shopify

Shopify provides a software platform that consolidates and integrates all the various IT services necessary to operate an ecommerce business. Most of the value is provided by Shopify directly, though it has also created an app store and integrated it into its platform, allowing third party developers to provide services via apps from which Shopify takes a commission.

Shopify’s customers are primarily small businesses, though it does also have a number of larger customers. It is a Canadian business with most of its operations focused in North America, though it has also been expanding globally. It is currently worth around £67bn, though its revenues are under £5bn, so a lot of this valuation is predicated on its future potential to join the ranks of the tech giants.

Quality

  • Business economics: Shopify monetises its platform primarily through charging subscriptions to merchants for the overall service subscription. It also charges for an increasing number of add-on services and takes a commission from apps sold in its app store. The subscription business model generates increasing recurring revenues. Despite a fairly high churn rate from its small business customers frequently failing, this is more than compensated by those that are successful generating increasing revenues through moving on to more premium services and buying more add-on services. The business model is highly scaleable with most costs being fixed rather than varying with the number of customers. Shopify has only recently become profitable. While it continues to invest a lot in IT development and now physical infrastructure to provide delivery services for its merchants, it is scaling very rapidly and at some point should become very profitable, though exactly how profitable is uncertain.
  • Track record: Shopify is a youthful business founded not that long ago in 2006, famously the ‘accidental’ by-product of its CEO (Tobias Lutke’s) attempt to run an online snowboard shop. So its track record is not that long. However, it has obviously done spectacularly well since then to get to its current position, consistently growing revenues at a break-neck pace.
  • Competitive advantage: one of the main attractions of Shopify is that it has a lot of qualities that should result in a strong and enduring competitive advantage. It is a clear leader in its niche. Other similar competitors like BigCommerce are much smaller and clearly inferior. Shopify benefits from the quality of its offering and various scale advantages eg in analytics data, in network effects from third party apps on its platform, its integrations and partnerships with other large platforms, and its distribution network. Its services should also be quite ‘sticky’ – as merchants rely on Shopify essentially to run their whole business it becomes more difficult for them to switch to alternatives. Shopify’s lead makes it seem pretty unlikely that it will face meaningful competition from any rivals trying to do the same thing. However, more broadly it does face competition from Amazon as an alternative way for small businesses to sell to consumers. Shopify is a distant second to Amazon in terms of its current scale and Amazon’s scale does provide it with a significant advantage in having a pool of active customers for merchants to sell to and a highly sophisticated distribution network. However, Shopify is highly differentiated from Amazon in that it provides its merchants with a much wider set of tools necessary to run their business and allows them create their own brand, without taking a huge cut of their revenues in commission.
  • Growth prospects: the other main attraction of Shopify is its growth prospects. Its business is highly scalable and currently growing very rapidly. There are a lot of strong growth drivers: the overall growth of ecommerce, increasing adoption and growing market share, international expansion and a very high ‘optionality’ in potentially adding and growing various add-on services (eg other IT services, payment processing, marketing and advertising tools etc.).

Price

Momentum is poor. Shopify’s last results were disappointing as it lapped the lockdown-induced boom in ecommerce (in common with many other businesses). Its share price reacted poorly, compounding the effects of the recent sell-off in growth stocks. My purchases was an exercise in bottom-fishing. At the moment it does look like I was fairly successful in catching a short term low but the market could easily turn again so would be premature to call this a success. Shopify’s valuation is hard to assess as its not really possible to extrapolate its profitability and there is a huge degree of uncertainty about the scale of its growth runway. On the basis that there is a strong likelihood that Shopify will prove to be a long term winner, a price that had fallen by about two thirds from the highs and a P/S ratio of around 14 seemed reasonable to me. While there is of course a significant risk that something goes wrong, to me it seems like the kind of high growth share where the best time to buy is well before it starts trading at more reasonable multiples.

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