January 19, 2025
Most readers would already be aware that Shopify's (NYSE:SHOP) stock increased significantly by 25% over the past three months. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. Specifically, we decided to study Shopify's ROE in this article.
ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
Check out our latest analysis for Shopify
The formula for return on equity is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Shopify is:
14% = US$1.4b ÷ US$10b (Based on the trailing twelve months to September 2024).
The 'return' is the profit over the last twelve months. That means that for every $1 worth of shareholders' equity, the company generated $0.14 in profit.
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.
At first glance, Shopify seems to have a decent ROE. Even when compared to the industry average of 14% the company's ROE looks quite decent. As you might expect, the 16% net income decline reported by Shopify is a bit of a surprise. So, there might be some other aspects that could explain this. For example, it could be that the company has a high payout ratio or the business has allocated capital poorly, for instance.
However, when we compared Shopify's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 5.9% in the same period. This is quite worrisome.
Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Has the market priced in the future outlook for SHOP? You can find out in our latest intrinsic value infographic research report.
Because Shopify doesn't pay any regular dividends, we infer that it is retaining all of its profits, which is rather perplexing when you consider the fact that there is no earnings growth to show for it. So there could be some other explanations in that regard. For instance, the company's business may be deteriorating.
In total, it does look like Shopify has some positive aspects to its business. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE and and a high reinvestment rate. We believe that there might be some outside factors that could be having a negative impact on the business. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals?
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This article by Simply Wall St is general in nature.
We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice.
It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
