Could Etsy Be a Millionaire-Maker Stock?

Shares of online homemade goods marketplace Etsy (ETSY +0.17%) have taken a beating since the company's third-quarter update at the end of October. At their peak, shares were up over 200% in 2020 alone, so a breather was inevitable. But positive COVID-19 vaccine news from Pfizer and BioNTech added fuel to the fire, and the stock is down 18% from its all-time high as of this writing.

Looking years down the road, though, this small-ish e-commerce stock -- its market cap is currently $16 billion -- could be a lot bigger than it is today.  

Image source: Getty Images.

COVID-19, inflated segments of e-commerce, and a very large and growing pie

Etsy has carved out a large niche for itself in online commerce. The company primarily competes with online marketplaces for handmade and craft goods like Amazon Handmade and eBay, the latter of which has hauled in revenue of $12.2 billion over the last year, compared to Etsy's modest $1.38 billion.  

But Etsy has been making serious headway in 2020, as the economic lockdown in the spring and ongoing social distancing have accelerated the migration to e-commerce. Gross value of merchandise sold (GMS) on the platform has doubled through the first nine months of this year to $6.68 billion, and the sharp uptick has been a boon to the bottom line. Net income is up 211% to $201 million year to date -- good for a net profit margin of 18%. That's pretty good for a company that's still prioritizing growth over maximizing profitability.  

Some investors worry that an eventual end to the pandemic could tame these growth rates -- or worse, send Etsy into contraction. In conjunction with its third-quarter 2020 update, Etsy showed that excluding the sale of face masks, GMS growth would have been reduced from the 125% rate of growth during the second quarter and 116% pace during the third quarter to "only" 93% in both periods.

Furthermore, of the millions of first-time buyers that turned to Etsy for a face mask purchase, subsequent purchases were for more face masks rather than higher value items. Put simply, if the need for a mask diminishes over time, these buyers may not return. It's also hard to imagine the higher activity in the company's traditional top sales categories sustaining their recent momentum as effects from COVID-19 start to subside.

Data source: Etsy Q3 2020 earnings presentation. Table by author.

In support of small local business

While a conservative outlook that removes face mask sales from the long-term Etsy equation might make sense, there's no denying Etsy is onto something here. A slowdown in growth will no doubt be in order in 2021 as the company begins to lap its exceptional 2020 results, but Etsy is more than just seeing an increase in sales because people are stuck at home. In fact, according to data from the U.S. Census Bureau, American consumer spending on some of Etsy's top sales categories like home furnishings, apparel, accessories, and musical instruments and equipment (via its acquisition of Reverb last year) have declined this year overall -- while Etsy has continued to grow. This implies that Etsy and its small merchants and craftspeople aren't just expanding; they're gobbling up market share from elsewhere in the economy.

What's the key to success? According to CEO Josh Silverman, Etsy isn't simply an online marketplace. Rather, it's a place for consumers to find creatively-made and custom-produced items that reflect who they are, a place for people to connect with small businesses in their communities, as well as an outlet for thousands of new business owners and entrepreneurs to find patrons. That confluence of factors could be a strong tailwind that propels Etsy higher in the decade ahead.  

Now that Etsy has reached a profitable scale, any expansion from here on out could have a dramatic impact on its bottom line. Additional sales this year have led to even stronger profit growth, with net income up 211% through the first nine months of the year to $201 million. And cash and short-term investments totaled $1.5 billion at the end of September, compared to just $1.05 billion of debt. The company is thus well funded to continue its push into the world of digital commerce.  

And with all that said, it's important to remember that this is still a relatively small company that operates in a global space that is expected to account for over $23 trillion in spending in 2020. It might dwell in a small niche right now, but this stock has the makings of a millionaire-maker investment over the long term if Etsy's brand of e-commerce can continue to grow.