Better Buy: Shopify vs. Square

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="It's hard to believe, but e-commerce still only accounts for about 10% of all retail purchases in the United States. The runway for growth is enormous, which helps explain why the two companies we'll be looking at today –&nbsp;Shopify&nbsp;(NYSE: SHOP) and&nbsp;Square&nbsp;(NYSE: SQ)&nbsp;– have done so well: Each has both an e-commerce presence and a finger in brick-and-mortar sales.” data-reactid=”11″>It’s hard to believe, but e-commerce still only accounts for about 10% of all retail purchases in the United States. The runway for growth is enormous, which helps explain why the two companies we’ll be looking at today — Shopify (NYSE: SHOP) and Square (NYSE: SQ) — have done so well: Each has both an e-commerce presence and a finger in brick-and-mortar sales.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Over the past three years, the two stocks have produced&nbsp;average&nbsp;returns of 500%. But between them, which company is the better buy moving forward?” data-reactid=”12″>Over the past three years, the two stocks have produced average returns of 500%. But between them, which company is the better buy moving forward?

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Image source: Getty Images

Obviously, we can’t answer that with 100% certainty. But by comparing them on three different facets of performance, we can get a better idea of which is a more intriguing buy at today’s prices.

<h2 class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Financial fortitude” data-reactid=”26″>Financial fortitude

When investigating financial fortitude, there’s one question you should ask above all else: How would this company be affected by a prolonged economic downturn?

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Companies with lots of debt and meager cash flows are often in trouble — they're forced to narrow their scope and cede market share just to stay afloat. Those with lots of cash, on the other hand, have options, like buying back stock or acquiring rivals to&nbsp;gain&nbsp;market share.” data-reactid=”28″>Companies with lots of debt and meager cash flows are often in trouble — they’re forced to narrow their scope and cede market share just to stay afloat. Those with lots of cash, on the other hand, have options, like buying back stock or acquiring rivals to gain market share.

Here’s how Shopify and Square stack up in terms of financial fortitude.

Data source: Yahoo! Finance. Cash includes short and long-term investments. Free cash flow presented on a trailing twelve-month basis.

Both companies are decidedly on firm footing, and would likely continue to gain market share from a downturn. I would argue, however, that Shopify is slightly better positioned. 

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Shopify has no debt to speak of, which gives it more flexibility in a pinch. And while some may balk at the company's negative free cash flow, that is more management‘s choice — it could easily turn on the free cash flow spigot should circumstances require such a move.” data-reactid=”34″>Shopify has no debt to speak of, which gives it more flexibility in a pinch. And while some may balk at the company’s negative free cash flow, that is more management‘s choice — it could easily turn on the free cash flow spigot should circumstances require such a move.

Square would be just fine in a downturn, too, but Shopify would have more options.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Winner = Shopify” data-reactid=”36″>Winner = Shopify

<h2 class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Valuation” data-reactid=”37″>Valuation

Next we have valuation, which is a decidedly difficult task. Since there’s no one metric that tells investors if a stock is “cheap” or “expensive”, we can consult a number of different data points.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Data source: Yahoo! Finance, E*Trade. P/E = price to earnings. P/FCF = price to free cash flow. PEG = price to earnings growth. P/S = price to sales. P/E presented using non-GAAP earnings.&nbsp;” data-reactid=”41″>Data source: Yahoo! Finance, E*Trade. P/E = price to earnings. P/FCF = price to free cash flow. PEG = price to earnings growth. P/S = price to sales. P/E presented using non-GAAP earnings. 

Putting all of this data together, it should be clear that both of these stocks would be considered pricey by almost any standard. But between the two, Square is demonstrably cheaper…on every valuation metric.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Winner = Square” data-reactid=”43″>Winner = Square

<h2 class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Sustainable competitive advantages” data-reactid=”44″>Sustainable competitive advantages

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Finally, we have the most important aspect worth investigating: each company's sustainable competitive advantage, or its moat.” data-reactid=”45″>Finally, we have the most important aspect worth investigating: each company’s sustainable competitive advantage, or its moat.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Shopify's moat comes in two forms. The first is via high switching costs: When up-and-coming e-tailers use a single platform to manage their website, track sales, ship products, and collect payments, they don’t want to go through the hassle of changing platforms. They want to focus on whatever service or product they’re offering. That leads Shopify clients to stay with it for the long haul.” data-reactid=”46″>Shopify’s moat comes in two forms. The first is via high switching costs: When up-and-coming e-tailers use a single platform to manage their website, track sales, ship products, and collect payments, they don’t want to go through the hassle of changing platforms. They want to focus on whatever service or product they’re offering. That leads Shopify clients to stay with it for the long haul.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="But Shopify also benefits from powerful network effects — each additional merchant that joins makes the platform more powerful. But it’s not as straight-forward as you may think. Shopify has an App Store where third-party merchants can build tools for users.&nbsp;Those third-parties love that Shopify has over 800,000 merchants. More merchants mean more incentive for third-party tools, which leads to more merchants — a virtuous cycle.” data-reactid=”47″>But Shopify also benefits from powerful network effects — each additional merchant that joins makes the platform more powerful. But it’s not as straight-forward as you may think. Shopify has an App Store where third-party merchants can build tools for users. Those third-parties love that Shopify has over 800,000 merchants. More merchants mean more incentive for third-party tools, which leads to more merchants — a virtuous cycle.

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