Oftentimes, it is only in hindsight that we can recognize our most important financial decisions.
Such is my case: In January 2017, I purchased my first 10 shares of e-commerce specialist Shopify (NYSE: SHOP). The grand total for the purchase: $432. As of this writing (less than five years later), those shares are worth $15,150. That’s a return of 3,400% — making Shopify one of the greatest growth stocks of the past decade!
Here’s the thing: Shopify has some distinct characteristics that aren’t that hard to look for. By seeking out these characteristics in today’s smaller companies, I believe I have a decent chance of discovering another Shopify-like holding for my portfolio — and I’ve already put some skin in the game.
What makes Shopify so special?
I’ve written before about the “Antifragile Framework” I use for selecting stocks. It has led to market-thrashing results over the past decade. It can be summarized in three broad categories. Inspired by former trader and best-selling author Nassim Nicholas Taleb, the framework evaluates companies in three ways:
Barbell method: I’m looking for mission-driven companies that have a reliable revenue stream protected by a wide moat (low risk) while tinkering with other business lines (high risk).
Financial fortitude: I want companies with enough cash on hand to benefit from financial downturns while not relying heavily on any specific customers for a big chunk of sales.
Skin in the game: I love founder-led companies where insiders own lots of stock and employees are happy to come in every day.
While Shopify wasn’t free-cash-flow positive when I first invested, it checked all three boxes:
The company’s mission is “To make commerce better for everyone.” It was protected by two moats: high switching costs and network effects. Additionally, Shopify has come out with ever-more product lines — something referred to as “optionality.”
At the time, the company had far more cash on hand than debt.
Shopify is run by founder-CEO Tobi Lütke, who owned (and still owns) a sizable chunk of shares and earns rave reviews on Glassdoor.com.
While not every stock that shares these traits will produce Shopify-like results, the scales tilt in an investor’s favor when they are able to find them. Below are the three companies I am betting my own money on to do the same.
1. Semrush: It’s hard to get noticed these days
Our brains aren’t wired to handle all of the incoming information we get every day. Increasingly, that’s a huge problem for small and medium-sized businesses. How can you get on customer’s radar if they’re filtering everything out?
SEMrush Holdings (NYSE: SEMR) was founded to solve that problem. The company’s mission is “to help businesses reach the right audience … in the right context and through the right channels.” In other words, Semrush wants companies to connect with people who would truly benefit from their products — not just the industry players with the most cash.
It does that by offering a full suite of products that marketing departments can use, including search engine optimization (SEO), advertising, content marketing, social media, and more. There are companies that offer some of these services individually, and others that have more data (looking at you, Alphabet‘s Google and Facebook). But few offer such a wide suite while remaining agnostic (Google and Facebook tend to favor their own properties).
It shows in the company’s net revenue retention of 121%. In other words, existing customers are spending 21% more on average than they were one year ago. This indicates both high switching costs (marketing teams are relying more on Semrush) and optionality (existing customers are using more tools).
As for the rest of my framework, consider:
Free Cash Flow
Role of Founder
CEO and COO
While third-party cookies soon disappearing as a tool for companies like Semrush could create an obstacle, I still believe the deck is stacked in favor of the company.
2. PubMatic: Helping the internet’s content creators
It’s amazing how much we can learn — for free — today. That’s largely thanks to folks out there who share their knowledge with the world. Those same people, however, need to get paid. Oftentimes, that comes in the form of digital advertising on their sites.
PubMatic (NASDAQ: PUBM) was founded to help such people. Its mission is “to fuel the endless potential of Internet content creators.” It does that by providing a sell-side advertising platform that allows these folks to get the most bang for their buck.
Like Semrush, PubMatic sports impressive net revenue retention figures. Over the past 12 months, the number clocked in at 150%. In other words, PubMatic’s content creators placing ads on the platform were spending 50% more this year than last, again pointing to an impressive combination of high switching costs, network effects, and optionality.
And it doesn’t stop there:
Free Cash Flow
Role of Founder
The market has made clear Adtech companies that help the transition to digital marketing will be richly rewarded. There’s no guarantee PubMatic will be the next big winner, but I think the deck is stacked in its favor.
3. Riskified: No, really — you can trust this customer
Are you familiar with chargebacks? That’s when an e-commerce company sends a product to a customer, but the customer later claims they never got it. It leads not only to lost revenue and inventory — it’s also a nightmarish headache for internet retailers.
Riskified (NYSE: RSKD) was founded to solve this problem. The company’s mission is to create “frictionless fraud management” that helps the world’s largest retailers increase sales and reduce fraud. It has a suite of products that help these companies approve loans they might otherwise deny due to chargebacks. Because of that, Riskified’s platform also increases sales — all while guaranteeing to cover the costs when it is wrong!
The company went public this past summer. Get this: If you exclude the effect of Riskified’s travel and ticketing customers (both of whom were severely hit by COVID-19), the company’s annual dollar retention rate was an astounding 158%. In other words, existing customers were paying Riskified 58% more to approve purchases. Again, that’s a huge sign of high switching costs, network effects (thanks to artificial intelligence improving with more data), and optionality.
The positive signals don’t stop there:
Free Cash Flow
Role of Founder
CEO & CTO
While Riskified’s stock price is down more than 40% from its all-time highs set in early September, I’m willing to sit tight. This level of volatility isn’t uncommon among newly public companies (its initial public offering was July 29). Patience is warranted.
A word of advice
It’s important to note that none of these stocks is guaranteed to produce Shopify-like results. That’s why I have put less than 1% of my portfolio behind each of these stocks individually. If they falter, it won’t be a huge loss. But if they succeed, just a little skin in the game is all I’ll need (or you’ll need) to benefit.
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Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Randi Zuckerberg, a former director of market development and spokeswoman for Facebook and sister to its CEO, Mark Zuckerberg, is a member of The Motley Fool’s board of directors. Brian Stoffel owns shares of Alphabet (A shares), Alphabet (C shares), PubMatic, Inc., Riskified Ltd., SEMrush Holdings, Inc., and Shopify. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Meta Platforms, Inc., PubMatic, Inc., Riskified Ltd., and Shopify. The Motley Fool recommends the following options: long January 2023 $1,140 calls on Shopify and short January 2023 $1,160 calls on Shopify. The Motley Fool has a disclosure policy.