Shares of retail software provider Shopify (NYSE: SHOP) have traded lower since the company missed earnings estimates on Tuesday. The company’s stock price initially fell as much as 8% but has since recovered some ground.

The knee jerk selloff ended when the market realized that the loss was largely due to an income tax charge. However, revenue growth is also slowing faster than many anticipated. Given the high valuation, the stock price may consolidate until the price to sales ratio unwinds.


Income Hit by Tax Charge

Third-quarter revenue rose 44.6% to $390 million, which was a little higher than expected. However, the Non-GAAP loss per share was $0.29, 39 cents worse than expected.

The GAAP compliant loss per share was also 35 cents lower than expected at $0.64. This compares to a 26-cent loss in the previous quarter and 22 cents in the third quarter last year.

The wider than expected loss was attributable to an income tax expense. The $48 million charge was the first the company has paid and widened the operating loss from $28.7 million in the previous quarter to $72.8 million. Excluding this charge, the operating loss would have been flat year-on-year.

The gross margin was flat from a year earlier and down 1% from the past two quarters. Operating expenses as a percentage of revenue improved slightly from previous quarters.


Revenue Growth Decelerating

Perhaps the most important number from the results was year-on-year revenue growth which slowed from 57% a year ago, and 47.7% last quarter, to 44.6%.

Subscription revenue grew 37%, down slightly from last quarter and merchant solutions revenue grew 50%, down from 56% in the previous quarter. Gross merchant volumes grew 48% to 14.8 billion, compared to 51% a year ago.

Management expects fourth-quarter revenue of between $472 and $482 million. This puts the range above the $471 million the market is looking for. Revenue for the fourth quarter will, therefore, be 37 to 40% higher than a year ago.

Perhaps the most important number from the results was year-on-year revenue growth which slowed from 57% a year ago, and 47.7% last quarter, to 44.6%. The company’s outlook suggests the deceleration will continue. While margins are improving, revenue growth is slowing more rapidly.


Does Growth Justify the Valuation?

The company is trading at 25 times sales, which is expensive when you consider it is probably quite a long way from being profitable. Shopify may well need to keep spending at the current rate to fend off competitors, but revenue needs to grow faster than expenses. The sales growth trajectory will begin to worry investors if it continues at the current rates. The market is also beginning to grow cautious of SaaS companies, particularly those that aren’t profitable.

Shopify is a market favourite and investors are likely to stick with the company for the foreseeable future. However, this set of results, and possibly the next are unlikely to attract serious new buying. The share price may well consolidate for the next quarter or two, until earnings begin to justify the valuation.

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