The coronavirus pandemic brought nearly 25 million new active buyers to Etsy's (ETSY -0.72%) marketplace, creating a massive acceleration in revenue growth through the third quarter of 2020. The stock has soared over 300% over the last year, but what happens to Etsy's momentum after the pandemic is over?
Wall Street analysts already expect revenue growth to decelerate this year, but Etsy could surprise if it can keep new buyers coming back. There are a few factors at play that could keep Etsy growing strong in 2021.
The consensus analyst estimate has Etsy growing revenue by 12% in 2021. Etsy will face difficult year-over-year growth comparisons, with revenue growth clocking in at 102% year over year for the nine-month period that ended in September 2020.
If Etsy struggles to gain enough new buyers to sustain its recent momentum, that could weigh on the stock's performance in the near term. The stock currently trades for a price-to-free cash flow multiple of 58, which assumes a high rate of future growth.
Etsy's high valuation might give some investors pause, but the shares are still attractive relative to other top e-commerce stocks. For example, Amazon trades at 64 times free cash flow, somewhat more expensive. However, the e-commerce giant is not growing as fast as Etsy.
Amazon grew revenue by 44% and 37% over the last two quarters, while Etsy sustained triple-digit growth rates in the second and third quarters. Etsy will report its fourth-quarter results on Feb. 25, and analysts expect Etsy to post revenue growth of 89%.
Investors should expect Etsy to show some level of deceleration in revenue growth this year. But there are some encouraging trends happening that might be causing investors to underestimate Etsy's ability to drive repeat purchases from its 69 million active buyers.
Keeping new buyers engaged
Keep in mind that most of Etsy's growth last year was for non-COVID-19 related items. Millions of new buyers discovered that Etsy is a good place to find a wide variety of items they can't find at mass retail stores, which fueled its momentum.
Moreover, Etsy's brand awareness is rising, thanks to effective marketing. During an investor conference in November, management cited research that shows the Etsy brand moving up the list of preferred places to shop for different retail categories, including jewelry, clothing, and home furnishings. One reason for the increased satisfaction is the personalization that Etsy sellers can provide buyers, which distinguishes Etsy from other mass-market retailers.
Also, the improvements management has made to the search and discovery process have been huge in driving engagement. Etsy has made great strides to personalize each buyer's search results, based on their previous search history. By using advanced machine learning technology, no two buyers will see the same items appear after searching the same keyword. Little things like this go a long way to increasing purchase activity and customer satisfaction.
Can the stock still go higher?
There is a wide range of potential outcomes for Etsy this year, since it's impossible to know what consumer behavior will look like when vaccines are more widely available. The best thing we can do is look at Etsy's stock against its pre-pandemic performance.
Etsy doesn't have to sustain super high growth rates in revenue to justify its lofty stock price. In the big picture, a price-to-free cash flow ratio of 58 is not that high for a business that is capable of growing revenue above 30%, as Etsy was doing through 2019.
It's also important to remember that valuations mostly reflect long-term growth expectations. Etsy has proven over the last year it can compete in some of the largest retail categories, and management feels that Etsy is still in the early innings of its growth potential just in the U.S. alone.
For these reasons, investors might still be underestimating this growth stock.