Shopify (SHOP.TO) briefly overtook Royal Bank of Canada (RY.TO) this month to become the country’s most valuable company, fuelled by investor excitement over its second-quarter earnings. However, a question remains: is its lofty valuation justified?

On Aug. 6, the company’s market cap surged to $276 billion as its shares climbed over 20 per cent after the e-commerce giant posted Q2 profit of US$906 million, a jump from the US$171 million it earned in the same quarter last year. Shopify’s market cap has since fallen to $248.5 billion, putting it back below RBC’s.

Shopify’s growth is, in part, fuelled by optimism around its new AI tools, including an AI-powered store builder, a universal cart that allows shoppers to buy from multiple stores in a single checkout, and a new product discovery tool called Catalog. User feedback on platforms like Reddit and X suggests that existing AI integrations, such as the AI assistant Sidekick, are already resonating with merchants, says Martin Toner, an analyst at ATB Capital Markets. This positions Shopify as a strong contender to benefit from the AI boom, he adds.

While Shopify has the potential to be a genuine AI-era growth engine, the stock already trades as if it is, which makes it risky and leaves less room for further upside. Following Shopify’s second-quarter earnings, Toner downgraded the stock from “outperform” to “sector perform.”

He explains his decision by noting that the stock was trading at more than 15 times its price-to-sales ratio. The company has about 50 per cent gross margin, so that means it’s trading at 30 times gross profit and even higher on a real bottomline profit multiple like EBITDA, Toner says. “At some point, it’s just hard for them to grow into that high valuation,” he added.

Using a discounted cash flow model, Toner notes, the company would need to compound its growth at 25 per cent for 10 years and reach “well over a trillion dollars” in gross merchandise value, making it difficult to justify much more upside, he says.

However, Toner acknowledges that Shopify’s high price-to-earnings ratio of 76.5 implies a significant amount of future growth and margin expansions. If the company can grow by 30 per cent and double its margins, the price-to-earnings ratio could fall to 30x, he says, a multiple similar to that of Microsoft. In this context, Toner says, “it is not that hard to grow into.”

He also notes that Shopify does stand out as a potential winner in the age of AI because it’s not spending as much on capital expenditure as global tech giants like Google and Microsoft. While some tech companies succeeded over the last decade by not spending heavily on hard assets, that is changing as many invest significant sums in AI data centres and other capital projects.