Shopify stock is rising this week. Here’s why.

Actions of Shopify (STORE 7.29%) rose more than 25% this week, according to data from S&P Global Market Intelligence. The e-commerce software and payments platform reported second-quarter earnings that wowed investors. After seeing growth slow from the boom of the COVID-19 pandemic, Shopify has recovered and is now generating a solid amount of profits. However, the stock is still down year-to-date after the close on Thursday, August 8.

Here’s why Shopify stock soared 25% higher this week.

Solid growth, growing margins

In the second quarter of 2024, Shopify’s revenue grew 21% to $2 billion. This was driven by more spending on Shopify-powered commerce websites — known as gross merchandise volume (GMV) — which grew 22% year over year. Sixty-one percent of Shopify’s payment volume is now processed by its internal payment systems, which come with a higher take rate and therefore drive increased revenue for the business. Last year, in the second quarter, that number was 58%.

After price increases for monthly subscription fees, the subscription segment grew 27% year-over-year to $563 million in revenue. This is impressive and shows that Shopify has a lot of pricing power with its merchant customers.

Even more impressive is Shopify’s profitability, which has improved tremendously even as it invests for growth. Operating margin jumped into positive territory over the past 12 months, a sharp jump from the heavy losses it had a year ago. Free cash flow margin increased to 16%, equivalent to $333 million in free cash flow in the quarter. In the past 12 months, it has generated more than $1 billion in free cash flow.

Is the stock a buy?

After surging 25% this week, Shopify now trades at a market cap of $88 billion. Its revenue continues to grow, management is flexing its pricing power, and its free cash flow margin is expanding. Even so, the stock still looks expensive.

The company generated barely $1 billion in free cash flow over the past 12 months, or a multiple of 88 times its current market cap. Most stocks trade at 10x to 30x free cash flow. Sure, Shopify’s revenue is growing fast, reaching $7.5 billion in the past 12 months. Let’s say revenue hits $10 billion and free cash flow margin hits 20% in a few years. That equates to $2 billion in free cash flow, or still more than a 40x multiple compared to the current market cap.

If you buy Shopify stock after this increase, you have to trust that the 20% revenue growth will continue with the margin expansion. If not, the stock is probably overvalued at these prices.