Etsy (NASDAQ:ETSY) is an e-commerce site that differentiates itself from the competition by providing a marketplace for independent sellers offering handmade goods and other crafted items. This niche enables Etsy to provide unique products to attract shoppers.

When I first wrote about Etsy last September, shares were battered by an underwhelming quarterly report, but I believed the stock would recover. With its 2020 first-quarter earnings results, the stock skyrocketed, hitting a 52-week high of $88.02 on May 18.

Is it too late for investors to obtain outsize returns from Etsy? Let's dive into the company's business to answer that question.

A woman at a worktable with a laptop creates a handmade object.

Image source: Getty Images.

The growth

What makes Etsy a compelling investment is the combination of ongoing growth in the overall e-commerce sector and its niche platform focused on handmade, vintage, and other specialized products. The first-quarter report underscores these advantages.

The results were strong despite a global economic downturn. The pandemic resulted in government lockdowns that hurt the retail industry, with mandatory store closures and shelter-at-home orders. In this environment, consumers shopped online, and Etsy benefited.

Revenue was $228 million in the first quarter, up 34.7% year-over-year. Its gross merchandise sales (GMS), the dollar value of all products sold on its platform, rose to $1.35 billion from $1.02 billion in the prior-year quarter.

The company's revenue was also helped by the growth of services it offers sellers, the main one being advertising to help sellers promote their products. This part of the business rose from 25% of revenue in the first quarter of 2019 to nearly 32% this year, driven by 71% growth.

Management noted the strong performance extended beyond the first quarter into April with an approximately 130% GMS increase that month. However, the company expects this spike in demand to level out as lockdowns ease, and economies return to normal.

Still, Etsy forecasts its second-quarter revenue will grow 70% to 90% year over year, a continuation of the steady progress it has shown over time.

ETSY Revenue (Quarterly) Chart

Data by YCharts.

Overall, Etsy continues to benefit from the growing consumer shift to online shopping -- in 2019, e-commerce's share of global retail sales was just 14%, and that share is forecast to grow to 22% by 2023.

The virtuous cycle

What's the secret to Etsy's e-commerce success? The company itself doesn't sell any merchandise. Instead, it facilitates transactions between the sellers and buyers on its platform, and this requires a careful balancing act to nurture marketplace activity.

Etsy has to offer services and features that attract shoppers and encourage them to buy, such as free shipping, while balancing the needs of its sellers. So far, it has succeeded, as demonstrated by the year-over-year growth in active sellers and buyers. At the end of the first quarter, Etsy had 2.81 million active sellers, up from 2.23 million last year, as well as 47.75 million active buyers, up from 41.03 million.

The company's network of independent sellers is rising to meet the demand of consumers who are seeking unique and environmentally sustainable items. And as consumers become aware of the scale of the marketplace, even more will flock to Etsy and become potential buyers. That attracts even more craftsman and entrepreneurs, and the cycle continues.

The company also boasts solid financials. At the end of the first quarter, it had $804 million in cash and short-term investments, and total debt stood at $794 million.

The bottom line

Etsy is positioned to grow its share of the e-commerce pie, making it a solid investment choice. But when it comes to the kind of returns needed to make investors millionaires, its key strength is also a limitation. The unique products on its site limit its target market -- there are only so many shoppers and sellers to fill this niche.

This means that even as a growth stock, Etsy is unlikely to reach the mega-scale of top retailers and e-commerce operations. This puts a cap on the company's growth potential, preventing it from delivering the kind of returns necessary to be a millionaire maker.