1 Growth Stocks Down 59% to Buy Now

Warren Buffett believes in buying great companies, even if it means paying a small premium. He has bought shares of a company countless times, only to buy more shares later at an even higher price. “It’s far better to buy a great company at a fair price than a fair company at a great price,” he once joked.

But sometimes you can buy a wonderful company at a wonderful price. This possibility is now a reality Online shop (STORE 0.84%) a stock that’s down 59% over the past three years. There are two key reasons why this company should join your portfolio today.

Shopify is a growth star

Consider iconic companies such as Visa, Meta PlatformsAND Amazon. All of these companies benefit from network effects. Network effects describe how a particular product or service gains value when more people use it. For example, as more people use Visa credit cards, more merchants are encouraged to accept them, which only spurs more consumer adoption. The same is true for social networks like Facebook and Instagram—both of which are Meta Platforms. The same is true for Amazon, which attracts more merchants by adding more customers, and attracts more customers by adding more merchants.

There’s a reason Visa, Meta Platforms, and Amazon are among the most valuable companies in the world. Once they’re up and running, network effects are hard to stop. Because these markets benefit from scale, they naturally lead to industry consolidation. All three, for example, dominate their industries with massive market shares.

When it comes to network effects, Shopify ranks right up there with Visa, Amazon, and Meta Platforms. At its core, Shopify is an e-commerce company. But it doesn’t sell directly to consumers. Instead, it runs the software that enables more than a million retailers to sell online. With a few clicks, anyone can start selling online, and design, inventory, payments, and advertising features are built into a Shopify-powered website. According to Statista, Shopify controls 28% of the U.S. e-commerce platform market—almost as much as its next two competitors combined. And there’s reason to believe that this market dominance will only expand.

How exactly does Shopify use network effects? In two ways.

First, customers looking for an e-commerce platform to run their online sales channels are encouraged to choose the platform with the most functionality. Platforms that allow users to sell more products smarter and faster win. Shopify solved this problem by allowing any third-party developer to create features for the platform. These new features are monetized, and the creator gets paid every time a Shopify user uses their creation. Developers want to contribute to the platform that gives them the best chance of getting paid. As the market leader with the most users, Shopify is an attractive choice, especially since developers keep 100% of the revenue they generate up to the first million dollars in earnings. Because Shopify is the most attractive platform for developers, it has an advantage in adding new features and capabilities. This attracts more users, which only attracts more developers—a vicious cycle generated by network effects.

Shopify also benefits from the network effects of AI. E-commerce is a huge market. Global e-commerce spending is expected to exceed $8 trillion by 2027. Much of that will go to massive, centralized marketplaces like Amazon. However, a significant portion will also go to individual e-commerce sites like those operated by Shopify. As mentioned, e-commerce platforms that make the most money for merchants will win in the long run. As its biggest competitor, Shopify has more investment funds than its competitors.

This is especially useful given the rise of artificial intelligence (AI). AI development is expensive, but it can help retailers optimize inventory, better serve relevant search results, interact with customers in real time, and increase ad conversions. AI technologies require data sets to train and improve over time. The bigger the data set, the better the AI ​​model can become. As the largest e-commerce platform, Shopify has more users, more customer interactions, and more payment transactions to use as data for AI-enabled features. This allows it to create better AI tools, attracting even more customers by adding even more data to its AI tools to improve themselves—another network effect in action.

While Shopify’s growth rates have slowed dramatically as the company has grown, revenue has continued to consistently grow by more than 20% annually. Given that e-commerce spending is growing by about 7% annually, and that network effects should allow Shopify to take market share from its competitors for years to come, it shouldn’t be hard for the company to sustain double-digit growth rates over the next decade. Profit growth should follow later. Wall Street analysts, for example, expect Shopify to grow profits by an astonishing 36% annually over the next five years.

SHOP Revenue Data (QoQ growth YOY) by YCharts

For this reason, the stock is worth buying

Growth is just one side of the coin. There’s also the price you have to pay for the stock. Shopify stock is undoubtedly trading at a premium, but it’s relatively cheap after the recent correction.

Shopify stock currently trades at 11 times sales. In early 2024, it was trading at nearly 17 times sales. In 2020, when revenue growth rates exceeded 100% annually, the stock traded at over 60 times sales! Of course, those days of seismic growth are far behind us. But as we’ve learned, the massive and growing e-commerce market gives Shopify the benefit of long-term growth. In the meantime, network effects will allow it to outpace that underlying market growth.

Based on next year’s sales, Shopify is trading at just 7.9 times sales. That’s still expensive, but given the consistently high growth rates, it’s easy to see how Shopify stock today could look like a bargain in a few years. This investment will take patience to pay off, and the initial premium is hard to swallow. But as Warren Buffett advises, paying a premium for a quality company like Shopify is usually a smart decision. Just make sure your investment horizon is long enough to stomach the volatility.

Randi Zuckerberg, former chief market development officer and spokeswoman for Facebook and sister of Meta Platforms CEO Mark Zuckerberg, is a member of The Motley Fool’s board of directors. John Mackey, former CEO of Whole Foods Market, a subsidiary of Amazon, is a member of The Motley Fool’s board of directors. Ryan Vanzo holds positions in Shopify. The Motley Fool holds positions in and recommends Amazon, Meta Platforms, Shopify, and Visa. The Motley Fool has a disclosure policy.