Stock Market Sell-Off: Is Etsy a Buy?

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Etsy (ETSY 0.04%), the popular marketplace for handcrafted, vintage, and other unique goods, saw its shares end 2022 down 45% on the year. This company, which was a huge favorite during the pandemic, experienced a dramatic slowdown in its business as it lapped difficult comparisons from 2021 and consumer shopping behavior normalized in favor of in-person retail.

Nonetheless, investors might be eyeing the company as the valuation now looks more attractive. Let’s see if Etsy stock is a buy. 

The positives 

In the hyper-competitive e-commerce landscape, where shoppers have an unlimited number of choices at their fingertips, Etsy stands out from the crowd. According to a survey by the platform, 87% of its buyers said that the marketplace had items that they couldn’t find anywhere else. So its focus on unique merchandise has created a recognized brand. 

Anyone who has followed Etsy is probably impressed with its outstanding financials. Between 2016 and 2021, it increased revenue from $365 million to $2.3 billion. And during that same time, its operating margin expanded significantly from 5.1% to 21.6%. The result is an asset-light, highly cash-generative enterprise that scales extremely well. 

Profitability stems in large part from its network effect, a key competitive advantage. As the company attracts more buyers, existing merchants immediately have a larger pool of potential customers; meanwhile, new merchants will find more value in selling on Etsy. And with more merchants, buyers are presented with an increasing selection of goods to buy. 

These favorable attributes can all be purchased by investors at a price-to-earnings (P/E) ratio of under 36, which is well below the trailing-five-year average multiple — a valuation that might look attractive for investors who believe in Etsy’s prospects. 

The negatives 

However, nayayers might call Etsy’s differentiated products a disadvantage. The company sells items for special occasions in customers’ lives, which doesn’t really lend itself to repeat purchases.

Furthermore, Etsy excels in discretionary categories, like jewelry and home furnishings — items that people won’t hesitate to delay buying when the economy is tough. How will gross merchandise sales and revenue hold up if we enter a full-blown recession in 2023? I’m guessing that it won’t be so good. 

Etsy underwent major growth during the pandemic, but that has slowed down substantially. Revenue only increased 9.1% in the first nine months of 2022 compared to the same period in 2021, a huge deceleration from prior years.

What’s most alarming is the fact that Etsy’s 94.1 million active buyers and 7.4 million active sellers in the recent quarter were both lower year over year. This could just be a post-pandemic normalization or it could be indicative of a new reality for the business in which growth will be slower. 

And during the third quarter of 2022, management wrote down the value of its 2021 acquisitions of merchandise sites Depop and Elo7, which resulted in a nearly $1 billion net loss in the three-month period.

Etsy’s profitability and financial situation are clear bright spots when looking at the company, but this impairment charge is a sign that the business overpaid for those acquisitions. This definitely calls management’s capital allocation into question. 

Investor takeaway 

I think both the bull and bear arguments for Etsy merit serious consideration, and what factors matter most to investors will swing the debate.

Etsy’s growth over the years and its profitability have been spectacular despite the recent slowdown. But investors might view these gains as a thing of the past. The growth of Etsy’s user base has stalled and the platform faces some near-term headwinds if there is a recession. 

Neil Patel has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Etsy. The Motley Fool has a disclosure policy.