Valuations are entering absolutely absurd levels. At least, according to Prem Watsa, CEO of Fairfax Financial.
In a recent video call with investors, Mr Watsa pointed out that Shopify (TSX: SHOP) (NYSE: SHOP) is worth more than Royal Bank of Canada (TSX: RY) (NYSE: RY). The kicker: Shopify’s revenue is lower than Royal Bank’s revenue.
This valuation gap is not unheard of among many small cap companies. However, the absolute size of Shopify’s market cap is staggering; Shopify is now the largest listed company in Canada.
Shopify a large company
The valuation of Shopify is a reflection on the fact that it is a game-changer in the world of e-commerce. The company is truly a world-class gem that investors are right to want to hold as a staple of their portfolio.
The Shopify platform has become essential for so many small and medium businesses (SMBs). In the era of the coronavirus pandemic, Shopify’s merchant platform made the difference between life and death for many small businesses. This has enabled continued growth at a time when most companies are struggling to consolidate their balance sheets. Shopify’s cash position and its ability to innovate and grow through the turbulent times we find ourselves in is critical. This makes investors see Shopify as a security game, rather than just another overpriced tech title.
Shopify’s business model isn’t the issue; it’s valuation
That said, even the largest companies can be overvalued from time to time.
Shopify is not alone in this regard. Many of the US-listed mega-cap tech companies have seen their valuations soar to levels not seen in some time. The dot-com bubble is often cited as the most recent example where we have seen such valuations on the NASDAQ.
Some investors say high valuations are here to stay, especially if interest rates stay low for a very long time. That said, in the very long term, valuations tend to revert to the long term average. Momentum investors could experience a sharp wake-up call if we see such a scenario unfold.
At the end of the line
Valuations matter to all investors. Those looking to put money to work today need to balance the fact that asset prices across the board have gone up. Loose monetary policy has led to inflation in the prices of real estate and other assets besides stocks. Getting a reasonable return in today’s market is not easy. Riding the wave of momentum also worked well, which makes the case for owning Shopify today intriguing.
With this in mind, investors should remain cautious about all investments. No investment should be made on the basis of historical returns, but rather on the discounted estimated future cash flows of said company. On that basis, long-term fundamental investors may be better suited to look to the royal banks of the world right now.
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Silly contributor Chris MacDonald has no position in any of the stocks mentioned. Tom Gardner owns shares of Shopify. The Motley Fool owns stocks and recommends Shopify and Shopify. The Motley Fool recommends FAIRFAX FINANCIAL HOLDINGS LTD.