What's Behind Shopify's 175% Surge in the Past 12 Months

Shopify (NYSE: SHOP) is one of the hottest stocks in tech right now, and it's showing no sign of slowing down.

In this Industry Focus: Tech segment, host Dylan Lewis is joined by analyst Michael Douglass and summer intern Ryan Reeves to explain what Shopify does, and how it makes money. Find out how the e-commerce platform brings in customers that range from small-time craft-goods makers to big brand names such as Tesla and Nestle; how CEO Tobi Lutke decided to found the company, some of the most important numbers investors should look at to track the company's progress, and more.

A full transcript follows the video.

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Dylan Lewis: This is a stock that has been on an absolute tear for the last year. In the last 12 months alone, it's up 175%. It's been a favorite of the investing team for quite some time, and I know it's actually a company that Ryan's been following for quite some time, so I wanted to bring him in to talk about it. To kick us off, how would you describe this company to someone who's never heard of it? What do they do, and how do they make money?

Ryan Reeves: Shopify is an e-commerce solutions company. They help you build your website; they help with inventory management; they integrate payments. They basically have two segments for how they make money -- subscriptions and merchant solutions. When you're trying to build an e-commerce platform, you can subscribe to Shopify and then you get access, and there's Basic Shopify and Advanced, and there's even Plus for enterprises. There's basically these four levels, and it varies by the number of features that you get. The merchant solutions is mainly Shopify payments. Based on the amount of merchandise that flows through your online business, you pay a percent of that to Shopify, so that you get the payments capabilities. Then, Shopify Merchant Solutions also has Shopify Shipping, Capital, and they even have a point-of-sale system that they rolled out pretty recently. So it's mainly these subscriptions and the merchant solutions, how they make money.

Lewis: This is kind of a one-stop shop, that's the idea, for people who want to get an e-commerce presence off the ground. And it's not limited to just your small Podunk yarn business or something like that. This is something that a lot of major brands actually use.

Reeves: Exactly. The Los Angeles Lakers, Tesla, Nestle, GE, Red Bull, all of them use Shopify Plus for the enterprise subscription. As of 2016, 378,000 total merchants, so Shopify is definitely gaining some traction there.

Michael Douglass: And it's so attractive in so many ways. Essentially, on the bottom end, when you're trying to start a business, you've got a lot of different things you have to think through, particularly hiring. On people, you have payroll, you have HR. Whatever you're actually doing to make money -- someone to essentially take all the e-commerce side of it and just make it a push of a button. Maybe not quite that simple, but pretty close. That's a really powerful value proposition to new entrepreneurs who are, frankly, often working 80 or 90 hours a week to get something off the ground. This basically takes a whole channel off your plate in terms of the work you have to do.

Lewis: And it's tech literacy that you don't necessarily need to have. It makes it easy and plug-and-play for a lot of people who might not have that expertise and really just want to be able to sell something that they might be selling on Etsy instead, but it allows them to control the experience a little bit more. I think one of the coolest things about this company is the back story, and how Tobias Lutke, the CEO, wound up deciding to actually found it. He did not get into this to start an e-commerce company; it was something that was born out of necessity for him.

Reeves: Yeah, exactly. The story kind of goes, Tobi got a computer when he was really young, and at about 11 or 12 he started programming, and he actually dropped out of school in the 10th grade in order to attend a coding school. Then, in 2004, he and a couple buddies wanted to sell snowboards online, and he found that there wasn't a good e-commerce software. So he was like, this is interesting, and he basically built out his own platform, i.e., Shopify. It was actually a funny story -- before 2011, the company was called Jaded Pixel Technologies.

Douglass: Not the best name there.

Reeves: [laughs] Yeah, thankfully they changed it to Shopify.

Lewis: Yeah, that name is both long and disillusioned. [laughs] Like, why are they jaded? Why are the pixels jaded?

Reeves: Yeah. But it's definitely had some serious success in the last couple years as the stock price has almost tripled. Yeah, Tobias Lutke.

Lewis: And something that we love to see as Foolish investors that's the case here with Shopify is, Tobias Lutke owns a sizable chunk of the business. I think he has about 8% of shares outstanding, if I remember correctly. So you like having a founder that's leading this company and has a substantial amount of skin in the game. Looking at their financial statements, not surprisingly, they paint the picture of growth. We've seen this incredible stock price rise over the last couple years. Looking at the most recent quarter, revenue was $127 million, and that was up 76% year over year. The company is currently losing money -- not really a huge surprise, though, given it's a fairly young and high-growth business. I know it's tempting to just look at these top-line numbers and also check in on the bottom line, but my feeling is, with a company like this, there are a lot of numbers that aren't on the financial statements that's probably worth checking in on. Do you want to walk through the important ones?

Reeves: Sure. One important one is GMV, or gross merchandise volume. That's basically the total amount of merchandise flowing through their customers' platforms. In 2016, that ended at $15.4 billion, growth of over 99%, actually. So they're looking to grow that. It will probably decelerate a little bit. But GMV, over $20 billion, for sure, which, that's crazy. Another metric to look at is average revenue per user. Last quarter, it grew 81%. Now it stands at over $1,200. As of 2016, they had almost 400,000 merchants at an average revenue per user of $1,200, so you can do some of the math, but that ends up at quite a bit of revenue. And you've seen the top line grow rapidly.

Lewis: And when we say "user" here, we're talking about the actual business owner that is running a site with them as an e-commerce solution, not the end user like you and I buying something, right?

Reeves: Exactly.

Lewis: It's worth clarifying, because very often that RPU number that we site --

Douglass: It's like $0.75.

Lewis: -- for social media companies like Facebook or Twitter, it's a little bit different.

Dylan Lewis owns shares of Facebook and Tesla. Michael Douglass owns shares of Facebook. Ryan Reeves owns shares of Shopify and Tesla. The Motley Fool owns shares of and recommends Etsy, Facebook, Shopify, Tesla, and Twitter. The Motley Fool owns shares of General Electric. The Motley Fool has a disclosure policy.