Owning shares in companies that scale up extremely well offers a solid path to stock market riches. This means that as the business's revenue grows, net income rises at a faster clip due to competitive advantages that keep rivals at bay.
Etsy (ETSY 0.01%), the burgeoning online marketplace for handmade goods, is rapidly widening its moat as it catches a ride in the ever-growing creator economy. Although the e-commerce company did benefit greatly from the economic situation created by the coronavirus pandemic, it was experiencing rapid growth in the years leading up to 2020 as well.
As such, the stock has the potential for compounding growth for a long time. Here's why I think it deserves a place in your portfolio.
Etsy has competitive advantages
All marketplace businesses are not created equal. Etsy's business model is more akin to Airbnb than it is to Uber. The company has a global pool of supply and demand with differentiated products like Airbnb does, and it isn't limited the way Uber's commoditized service is restricted to whatever market it happens to be in at the moment. In other words, there is no geographic restriction on making a transaction on Etsy.
This is a fantastic dynamic for Etsy, which now has 81.9 million active buyers and 4.4 million active sellers on its platform. Since the value proposition for buyers and sellers on the platform grows as more people use the service, Etsy benefits from strong network effects.
Based on monthly visits, it is now the fourth most-popular e-commerce site in the U.S., and the company noted that 88% of Etsy shoppers in a 2020 survey agreed that the Etsy marketplace has products that can't be found anywhere else. While it supports creative entrepreneurs on the seller side, on the buyer side Etsy allows customers to find unique products in tune with their individual identities.
The brand is clearly thriving as it continues to "keep commerce human," as management likes to say.
The growth outlook for Etsy is strong
According to management, the company has a potential $1.7 trillion market. Though I'm always skeptical when companies throw out big numbers like this, Etsy's $10.3 billion in gross merchandise sales in 2020 signals that there is still plenty of room to grow even if the total addressable market is much smaller.
Even narrowing down the potential market to only include relevant product categories for online spending in Etsy's six core geographies, (the U.S., the U.K., Canada, Germany, Australia, and France), the opportunity still is estimated at $249 billion, meaning that Etsy has only captured 4.1% of this more realistic potential market.
It's worth mentioning that the company just added India as a core market in February. With a middle-class population that could reach 600 million people by 2030, this could be an enormous opportunity for Etsy.
Etsy stock is a compounding machine
Revenue increased 111% in 2020, but net income skyrocketed 264%. As more transactions occur on its platform, Etsy's margins will continue to expand due to its network effects. So investors have nothing to do besides watch earnings (and the stock price) rise over time.
You'd be hard-pressed to find a stock that has outperformed Etsy's 2,270% return over the last five years, and I don't believe that the gains are done. The current sell-off could indicate a possible buying opportunity.
Investing in the stock market always comes with its own set of risks, and Etsy is no different in this regard. But buying this growth stock now could lead to a serious payoff for the patient investor.