Etsy Stock Surged 260% in 2020 -- Is It a Buy for 2021?

Etsy's (ETSY -2.17%) stock more than tripled this year as the pandemic caused more people to shop online. Orders for Etsy's handmade goods surged, while online sales of musical instruments at Reverb -- which it acquired last August -- jumped as brick-and-mortar stores closed down.

But as new vaccines arrive, investors might be wondering if they should take profits in Etsy and buy cheaper stocks that could rebound in a post-pandemic world instead. Let's look back at how rapidly Etsy grew in 2020, the main challenges it faces in 2021, and whether or not it's still worth buying.

How did Etsy impress the market?

Etsy's online marketplace for handmade goods flourished in Amazon's (AMZN -1.64%) shadow, for three simple reasons. First, Etsy enjoyed a first-mover advantage in the handmade market.

Image source: Getty Images.

Second, Etsy offered a simpler sign-up process, lower commissions, and more lenient rules regarding manufacturing and self-promotion than Amazon's rival platform, Amazon Handmade. It also charged basic listing fees instead of monthly fees like Amazon, which made it more attractive to smaller merchants.

Lastly, Etsy attracted younger shoppers who wanted unique gifts. Last year, a survey by The Harris Poll (commissioned by Faire) found 37% of millennial women in the U.S. preferred receiving handmade gifts over mass-produced ones, while 65% of all millennial shoppers preferred buying holiday gifts from independent retailers instead of big retailers.

Those strengths generated stable tailwinds for Etsy before the pandemic, but even more shoppers flocked to Etsy's platform as major retailers struggled with supply chain and logistics disruptions during the crisis. Orders of handmade products, especially face masks, surged as more people stayed home.

How fast is Etsy growing?

Etsy's revenue and adjusted EBITDA grew 36% and 34%, respectively, last year. Its total GMS (gross merchandise sales) rose 36%.

In the first nine months of 2020, Etsy's revenue jumped 102% year over year, its GMS rose 101%, and its adjusted EBITDA surged 171%. Reverb generated 9% of Etsy's total GMS during that period.

Etsy ended the third quarter with 3.68 million active sellers, up 42% from a year ago, as its number of active buyers grew 55% to 69.6 million. Etsy's gross and adjusted EBITDA margins also expanded year over year last quarter, but both figures dipped slightly quarter over quarter:

Source: Etsy.

Etsy's gross margin expanded as it shifted from on-site ads to off-site ads, which let merchants buy ads on Facebook, Alphabet's Google, Pinterest, and other platforms.

Those ads generate higher-margin revenue because Etsy doesn't host them on its own network. However, its gross margins seem to be peaking as its revenue growth decelerates into the end of the year. At the same time, Etsy's aggressive investments in new marketing campaigns and its growing headcount (which rose 6% sequentially and 14% year over year in the third quarter) are weighing down its adjusted EBITDA margins.

Investors should expect slower growth in 2021

For the fourth quarter, Etsy expects its revenue to rise 70%-90% year over year, its GMS to increase 65%-85%, and its adjusted EBITDA margin to decline to 24%-27% as it ramps up its spending.

Based on those expectations, analysts expect Etsy's revenue and earnings to rise 97% and 176%, respectively, for the full year. But next year, they expect its revenue and earnings to grow just 12% and 3%, respectively, as the pandemic passes and leaves it facing tough year-over-year comparisons.

That abrupt slowdown makes Etsy's stock difficult to value. It's not particularly cheap at 11 times next year's sales and about 70 times forward earnings, but it's more reasonably valued than other high-growth e-commerce companies.

The bulls will argue that Etsy's high growth rates, defensible niche, and resilience against Amazon, eBay, and other e-commerce competitors all justify that premium. The bears will claim Etsy's sales of masks (10% of its GMS last quarter) will decline after the pandemic ends, Reverb's growth will decelerate as more stores open, and online shoppers could gradually turn toward brick-and-mortar stores and larger retailers again.

Is Etsy a worthy buy for 2021?

Etsy's stock could still climb higher in 2021, but I don't believe it will double or triple again. The year-over-year comparisons are tough, and investors might shift toward higher-growth companies like Shopify, MercadoLibre and JD.com instead.

That being said, I still believe Etsy is a solid long-term investment. Investors might want to consider accumulating some shares throughout 2021, but they should do so in stages, maintain realistic expectations, and keep a close eye on its post-pandemic performance.