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New Purchase - Disciplined Growth Portfolio: Pullback Creates Opportunity

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We just made a new purchase in our Blue Harbinger Disciplined Growth portfolio. And before you start wondering, this is NOT a high-income investment. This is a powerful long-term cash flow thesis, and the recent short-term sell-off has created a compelling entry point that has caused us to hit the buy button.

 


The Trade:

Shopify (SHOP), Yield: 0.0%

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We bought shares of Shopify. If you don’t know:

Shopify operates a cloud-based commerce platform designed for small and medium-sized entrepreneurs. Its software is used to run a business across all sales channels, including web, tablet and mobile storefronts, social media storefronts, and brick-and-mortar and pop-up shops.

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The company has been growing at an amazing pace (as traditional brick-and-mortar retail slows, and other channels grow). We expect it to keep growing extremely fast for many years to come, while it also generates very high margins and tons of cash flow.

(If you are curious, you can check out Shopify here: Shopify.com).

Naysayers believe Shopify’s valuation is way too high, but they are making the classic Wall Street mistake of being way too shortsighted. The recent sell-off has created an attractive entry point.

Note: We funded this new purchase by selling our IBM shares (we sold 100% of our IBM shares in our Disciplined Growth portfolio, but continue to own IBM in our Blue Harbinger Income Equity portfolio only, for its low volatility, healthy dividend, and attractive valuation).

About Shopify

Retail is changing. Just 15 years ago, if you wanted to buy something you made a trip to the store. Now, we have websites, smart phones, social media, apps, and brick & mortar stores. Shopify helps merchants exist across all of these channels, and its business has been growing like wildfire. Here is a look at Shopify’s growing quarterly revenues.

And what makes this opportunity particularly powerful is that is has a ton more room for continued growth, as evidenced by its very large total addressable market (TAM):

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And that huge TAM is a lot bigger than Shopify’s total $0.85 billion in sales over the last 12 months.

And what makes this opportunity really attractive is that Shopify doesn’t have any direct competition at this point. Per Shopify’s CEO during the most recent quarterly call, Adobe’s (ABDE) Magento is the closest thing to competition right now, but it’s not really even close to a threat:

Adobe is a company I admire greatly. They have a lot of free cash flow. If they are willing to pump it all in, or much of it into Magento, maybe something interesting could come out of it. I would actually frankly welcome a strong competitor of some kind, because it's usually good for markets if people compete… There's no one else who sort of at least looks a little bit dangerous. So, that might be fun for everyone, I don't know. I can probably keep going and talk about another 50 irrelevant things about Magento. I think the main message is, I don't think it matters much.

And to make Shopify even more impressive, they have huge margins and they are generating tons of cash flow.

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But if Shopify is so great…

Why the Sell-Off?

Despite Shopify’s dramatically increasing price over the last year, the shares have recently sold-off from over $176 to around $143.

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The sell-off is due to a variety of factors:

(1) The company recently announced quarterly earnings whereby revenue didn’t grow at as fast of a percentage rate as previously (it’s still growing extremely fast, just less fast than in recent previous quarters).

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(2) Valuation is very high by traditional metrics (although we believe analysts are using the WRONG metrics). For example, many analyst don’t like that earnings per share is so low given the high revenues (see table above). However, EPS is low because the company is plowing all its cash back into the business (i.e. they are re-investing it) because the growth opportunities are so great. In Shopify’s case, the low earnings numbers are actually a good thing.

Next, the forward price-to-sales ratio (14.8x) is very high according to some analysts. However, this ratio only looks 1-year into the future (i.e. forward sales estimates) whereas Shopify is expected to have huge sales growth for many years into the future. The ratio is much more reasonable when you look further out (remember, Shopify is growing fast, it has a huge total addressable market, and it has essentially zero competition). Wall Street analysts are notoriously too shortsighted, and in this case it is causing them to dramatically undervalue Shopify. As evidence of Wall Street analysts being notoriously shortsighted, here is a look at their historical price target for Shopify.

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Notice, they update as often as monthly, and their price target is almost always very close to the current share price. However, over the last two years the share price has increased roughly 5x (and the Wall Street analysts certainly have NOT predicted this). Shopify is a classic example whereby Wall Street’s shortsightedness causes them to dramatically undervalue a stock. This stock has huge upside in the years ahead.

(3) Short-Interest: Lastly, because Wall Street is looking at the wrong (too shortsighted) metrics to value this company, there is a fair amount of short interest in the stock (currently 10.4% of float). When short interest is elevated (as it is for Shopify) it can cause the stock to be more volatile. On one hand, you need to be comfortable with the higher volatility if you’re going to own this stock, but on the other hand the volatility can create attractive buying opportunities such as the current one (i.e. the shares have recently sold-off), and the tremendous long-term growth story remains firmly intact, in our view.

* Also worth noting, there is a high level of inside ownership at Shopify (11.6% of the shares), which is a good thing, and the founder CEO also owns a lot (6.9% of the shares), also a good thing.

Conclusion:

If you are an entirely income-focused investor, skip Shopify. However, if you like to diversify your investment portfolio with some non-income ideas, Shopify is a rare and very powerful growth opportunity. It’s growing rapidly, and it is expected to keep growing rapidly considering its very large total addressable market (TAM) and its complete lack of any formidable competition. This is a powerful company in the right place at the right time. The shares can be volatile, and we just purchased shares on this latest pullback because we expect the price to increase dramatically in the years ahead.

For reference, you can view all of our current portfolio holdings here.

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