Etsy (NASDAQ:ETSY) and Alibaba (NYSE:BABA) have both generated impressive returns for investors over the past 12 months. Etsy's stock surged nearly 140% as its online orders jumped throughout the COVID-19 crisis, and Alibaba's stock rallied about 70% on similar tailwinds in China.

Etsy and Alibaba serve completely different markets, but both e-commerce companies might attract growth-oriented investors. Let's dig deeper into both companies to see which stock has more room to run.

A shopping basket button on a keyboard.

Image source: Getty Images.

The leader in handmade goods

Etsy is an online marketplace for handmade goods. It generates its revenue from listings, transactions, payment processing, and offline advertising fees. Merchants fulfill their own orders and either process payments with Etsy's services or PayPal.

Etsy acquired the online musical instruments marketplace Reverb last August. Reverb's sales notably spiked throughout the COVID-19 crisis as brick-and-mortar instrument retailers shut down.

Etsy's number of active sellers rose 35% to 3.14 million last quarter, as its number of active buyers grew 41% to 60.3 million. It generated about two-thirds of its gross merchandise sales (GMS) in the U.S. in the first half of 2020 and the rest from overseas markets. 

Amazon notably challenged Etsy with its own Handmade marketplace five years ago, but Etsy held its ground with its first mover's advantage, simpler sign-up process, lower commissions, lack of monthly fees, and more lenient rules regarding manufacturing and self-promotion. 

China's e-commerce and cloud leader

Alibaba's largest marketplaces, Taobao and Tmall, also generate their revenues from listing fees and commissions. Those listing fees make Alibaba China's largest digital advertising platform, even if it doesn't directly compete against traditional ad platforms like Baidu.

Parcels in a warehouse.

Image source: Getty Images.

Alibaba's merchants fulfill their own orders, but the company usually nudges them toward its majority-owned logistics service Cainiao. Payments on its marketplaces are usually processed by its affiliate, Alipay. The number of annual active customers on Alibaba's Chinese marketplaces rose 2% year over year to 726 million last quarter.

Alibaba's other notable marketplaces include its business-to-business platform Alibaba.com, its cross-border platforms Tmall Global, AliExpress, and Kaola, and the Southeast Asian marketplace Lazada. It also owns brick-and-mortar supermarkets and stakes in other retailers.

Alibaba generates most of its revenue and all of its profits from its core commerce business. Those profits subsidize the expansion of its unprofitable cloud, digital media, and innovation initiatives segments. Within those three businesses, Alibaba Cloud -- the largest cloud infrastructure platform in China -- generates the most revenue.

Which company is growing faster?

Etsy is gaining merchants and shoppers at a much faster rate than Alibaba, but it's also much smaller. Etsy doesn't even crack the top ten largest e-commerce companies in the U.S., according to eMarketer, while Alibaba controls over half of China's e-commerce market.

Etsy's revenue and earnings rose 36% and 25%, respectively, last year. In the first half of 2020, its revenue surged 87%, primarily fueled by the acquisition of Reverb, its aforementioned gains from brick-and-mortar retailers, and an acceleration in online purchases during the COVID-19 crisis. Its adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) soared 130%.

Etsy expects that momentum to continue in the third quarter, boosting its revenues 85% to 115% annually and its adjusted EBITDA 164% to 202%. It didn't provide any guidance for the full year, but analysts expect its revenue to rise 78% with 108% earnings growth. However, its revenue and earnings are only expected to rise 14% and 15%, respectively, in fiscal 2021 after it laps the Reverb acquisition and the COVID-19 tailwinds fade.

Alibaba's revenue rose 35% in fiscal 2020, which ended in March, as its adjusted earnings-per-share (EPS) grew 38%. It expects its revenue to rise at least 28% this year, and analysts expect its adjusted earnings to grow 16%.

Alibaba's overall growth looks stable, but it faces several looming challenges. It still faces intense competition from JD.com and Pinduoduo; its core commerce business margins are squeezed by its growing dependence on its lower-margin, cross-border platform and brick-and-mortar stores; and Tencent threatens its growth in the cloud, digital media, and fintech markets.

Alibaba also remains on the U.S. Trade Representative's "Notorious Markets" list due to the alleged sale of counterfeit goods on Taobao. A new Senate bill could force Alibaba and other Chinese stocks to delist their U.S. stocks if they don't comply with new regulations.

The valuations and verdict

Etsy's stock trades at nearly 120 times forward earnings, but Alibaba's forward price-to-earnings (P/E) ratio remains below 30. Investors are clearly willing to pay a premium for Etsy's growth and defensible niche, while they seem more wary of Alibaba's micro and macro challenges.

I'm still bullish on Etsy and Alibaba's long-term's prospects. But if I had to choose one over the other, I'd buy Alibaba for its scale, more diversified business, and lower valuation. Etsy is still a great growth stock, but its near-term catalysts are too ephemeral to justify its lofty valuation.