The S&P 500 (SNPINDEX: ^GSPC) returned an average of 169% during the dozen bull markets that have taken place since its creation in 1957. That statistic holds special weight today because the benchmark index is just 5 percentage points below its record high, meaning it is also 5 percentage points away from a new bull market (by the most conservative definition).
Investors who want to benefit should be buying stocks today. And even though the company has fallen out of favor, Etsy (ETSY 0.34%) is worth consideration. Its unique position in the e-commerce industry, coupled with its historically cheap valuation, makes it a compelling buy. Additionally, at less than $100 per share, the stock is widely accessible.
Etsy struggled in the third quarter, and the fourth quarter could be worse
The last few years have been a roller-coaster for Etsy. The company grew at a phenomenal pace during the pandemic as sellers pivoted to face masks and other household essentials, making the marketplace a go-to shopping destination for many consumers. But tailwinds arising from business closures and stimulus checks eventually subsided, replaced by inflationary headwinds that forced consumers to pull back on discretionary purchases.
Etsy has been hammered by those headwinds, and its financial performance in the third quarter continued to toe the line between mediocre and poor. Gross merchandise sales (GMS) rose just 1 percentage point, revenue increased 7% to $636 million, and non-GAAP EBITDA climbed 9% to $182 million. Management also provided disappointing guidance that calls for a low-single-digit decline in GMS in the fourth quarter in spite of holiday spending.
That said, management may have miscalculated. According to eMarketer, consumers set spending records between Black Friday and Cyber Monday, which could mean better-than-expected fourth-quarter results for Etsy. But even if the company continues to struggle in the near term, the investment thesis is not necessarily broken.
Etsy has a strong market presence and a sensible growth strategy
Etsy is the sixth-most popular online marketplace in the world as measured by monthly visitors. That speaks volumes about the viability of its business and the value it creates for consumers. Etsy specializes in non-commoditized products -- vintage, artisanal, and handmade goods -- many of which can be customized for individual buyers.
No other retailer offers a similar shopping experience on the same scale, and the network effect inherent to its marketplace should help Etsy maintain its niche in the e-commerce industry. The only issue is reaccelerating growth, but management is making sensible decisions aimed at boosting buyer engagement and purchase frequency.
For instance, Etsy is using artificial intelligence (AI) to improve search and discovery, an important focus area given that its marketplace features 120 million items, many of which are difficult to categorize due to their non-commoditized nature. So Etsy has deployed machine learning models that not only make search results more relevant and personal but also pull visually appealing products to the top. CEO Josh Silverman believes AI could "unlock an enormous amount of growth in the years to come."
Meanwhile, Etsy has also launched a purchase protection program, restructured its return policies, and increased the percentage of listings with expected delivery dates and tracking information. Those changes are aimed at building trust with consumers.
Etsy's sensible growth strategy seems to be working. Active buyers hit a record high in the third quarter, for the third consecutive quarter. Unfortunately, spend per active buyer continued to decline, offsetting the benefits of a larger consumer base. But there is reason to believe that trend will reverse course when economic conditions improve.
To quote CFO Rachel Glasser, "GMS from our buyers in the top decile of household income increased over 20% year over year in the third quarter, a positive indicator that Etsy's overall growth can improve as macro conditions stabilize over time."
Etsy stock trades at a historically cheap valuation
Etsy looked sluggish in the third quarter, and its fourth quarter report may be worse. But growth could re-accelerate as economic headwinds ease and the company makes progress on improving search functionality and building trust with buyers.
With that in mind, Morningstar analyst Sean Dunlop believes "Etsy is one of the few companies poised to be a long-term winner in e-commerce." He believes GMS on the marketplace could triple in the next decade, pushing revenue growth above 16% by 2025.
That forecast makes its current valuation of 3.8 times sales look downright cheap, especially when the three-year average is 9.1 times sales. Investors should feel very comfortable buying a small position in Etsy stock today.
