Etsy's (ETSY -0.81%) stock has surged more than 700% over the past five years as its online marketplace for handmade goods has attracted artisans and shoppers. Etsy has defended its niche against Amazon (AMZN 4.44%) and other challengers, while consistently generating double-digit revenue and earnings growth.
However, Etsy's stock now trades at over 130 times forward earnings, and investors might be wondering if its growth still justifies that premium valuation. Let's dig deeper to find out.
How did Etsy fend off Amazon?
When Amazon launched its Handmade marketplace in 2015, many media outlets dubbed it the "Etsy killer." But Etsy's first mover's advantage, simpler sign-up process, lower commissions, lack of monthly fees, and more lenient rules regarding manufacturing and self-promotion locked in its active sellers, which nearly doubled from 1.43 million to 2.81 million between the first quarters of 2015 and 2020.
During that period, Etsy's active buyers soared from 20.84 million to 47.75 million, as its marketplace attracted shoppers looking for unique gifts. Last year, a survey by Faire found 37% of Millennial women in the U.S. preferred receiving handmade gifts over mass-produced ones, and 65% of all Millennial shoppers preferred to buy holiday gifts from independent retailers instead of big retailers.
Those trends indicate Etsy will continue to fend off Amazon, which has repeatedly been accused of selling low-quality Chinese goods via its third-party marketplace to boost its e-commerce sales. Etsy also carved out another defensible niche with its acquisition of the musical instruments marketplace Reverb last August.
Can Etsy maintain its momentum?
Etsy's revenue and earnings rose 36% and 25%, respectively, last year. Its revenue grew 35% annually in the first quarter, but its earnings dropped 58% due to its purchase of Reverb, currency headwinds, and the impact of COVID-19 in March. But its adjusted EBITDA, which excludes most of those one-time expenses, still grew 10%.
For the second quarter, Etsy expects its revenue to jump 70%-90% annually for two reasons. First, Reverb became the primary retail channel for musical instruments when the COVID-19 crisis shut down brick-and-mortar stores, but that temporary boost should fade in the third quarter after it laps the acquisition and retailers reopen.
Second, Etsy's core marketplace posted a whopping 79% growth in April, as orders for its products -- especially handmade masks -- surged as larger retailers struggled to stabilize their supply chains and prioritize orders of essential products. But those tailwinds could also dissipate in the third quarter as shoppers buy fewer masks and larger retailers stabilize their businesses.
Etsy didn't provide any full-year guidance, but Wall Street expects its revenue and earnings to rise 43% and 25%, respectively. Investors should take those forecasts with a grain of salt, but they suggest Etsy's high-growth days are far from over.
Does Etsy's stock deserve its premium valuation?
Etsy's stock is trading at a lofty premium to its earnings growth, but it's arguably supported by three pillars.
First, its large base of artisans is well-insulated from Amazon and other retailers, since they create unique and handmade products. Second, Etsy's sellers create and ship their own products, which enables them to avoid the supply chain and logistics issues that have hobbled larger retailers throughout the crisis. Lastly, the first wave of COVID-19 infections actually generated tailwinds for Etsy -- and a second wave (which hopefully won't happen) would likely boost its orders again.
Since those three factors won't change anytime soon, I believe investors can still accumulate shares of Etsy even as it hovers near its all-time high. The stock could certainly pull back again in the future, but I think it's smarter to buy those dips instead of hastily taking profits.