Shopify Inc. (SHOP) has risen an incredible 270% so far in 2020, underpinned by the hyper-growth of its cloud-based multi-channel commerce platform for small and medium-sized businesses. The Ottawa-based company has blown past analyst and technical targets during the ascent, rewarding shareholders with windfall profits. However, high valuation could take a toll after the Oct. 29 earnings release if the company doesn't meet or exceed aggressive expectations.

Key Takeaway

  • Shopify stock has risen more than 270% so far in 2020.
  • The stock entered a holding pattern in July that could end after the Oct. 29 earnings release.
  • The company will likely need to meet or exceed aggressive estimates to avoid selling pressure.

The stock has been running in place since July while accumulation readings have ticked lower. There are two ways to interpret this price action: one for each side of the block. Bulls will say that this holding pattern is carving a correction through time rather than price and will act as a springboard for stronger returns. At the same time, bears will view this pause as proof of Shopify's high valuation and look for a long-term top that yields much lower prices.

Wall Street has grown more cautious on Shopify stock after the meteoric rise, dropping to a "Moderate Buy" rating based upon 10 "Buy," 15 "Hold," and 1 "Sell" recommendation. Price targets currently range from a low of $900 to a Street-high $1,400, while the stock opened Thursday's session about $80 below the median $1,133 target. These numbers look perfectly matched to current action, suggesting that buying interest will develop in coming weeks as long as there are no negative surprises.

Rich valuation refers to a security that is priced above expected levels. The term is applicable to the valuation of any asset, but it is most commonly used with reference to stock valuations. An asset that is trading at a rich valuation may have a risk/reward payoff that is not particularly attractive to value investors.

Shopify Weekly Chart (2015 – 2020)

SHOP
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Shopify came public at $28 in May 2015 and topped out in the low $40s in June. The subsequent downtick sliced through the IPO opening print before posting an all-time low at $18.48 in January 2016. The stock lifted into the prior high in August 2016 and broke out, but upside momentum didn't develop until year end. That buying impulse generated steady upside, stalling in the $170s in the second quarter of 2018.

Price action took off for the stars in December, carving a historic advance that nearly quadrupled the stock's price into the August 2019 high at $409.61. A January 2020 breakout failed in March, finding support below $300 before entering a momentum-fueled recovery that hit new highs again in April. It doubled once again into July, easing into a broadening formation, also known as a megaphone, with higher highs and lower lows.

A broadening formation is a price chart pattern identified by technical analysts. It is characterized by increasing price volatility and diagrammed as two diverging trendlines, one rising and one falling. It usually occurs after a significant rise, or fall, in the action of security prices. It is identified on a chart by a series of higher pivot highs and lower pivot lows.

Shopify Short-Term Outlook

This pattern sets off a red flag due to its bearish reputation, but the signal isn't strong enough to take immediate action. Accumulation has taken a minor hit since posting a new high at the end of July, but this activity looks like garden-variety profit-taking rather than a rush for the exits. In turn, the Oct. 29 confessional takes on greater importance, with positioned and non-positioned market players watching closely for directional clues.

The megaphone could be a tough pattern to play in this regard because a new high or new low might not generate sustained directional momentum. As a result, it makes sense to be cautious until a rally clears resistance at $1,210 or breaks support at $800. Keep a close eye on buying power at both ends because it won't take much effort to lift or drop accumulation through three-month trading ranges and establish early buy or sell signals.  

The Bottom Line

Shopify stock should head into the quarterly earnings release with market power equally divided between bulls and bears. As a result, price action after the report should closely align with quarterly metrics.

Disclosure: The author held no positions in the aforementioned securities at the time of publication.