In the transition to online shopping, Amazon (NASDAQ:AMZN) has claimed many victims. With convenience, low prices, and fast shipping on its side, competitors couldn't survive. One area Amazon has not penetrated is custom, hand-made goods. Etsy (NASDAQ:ETSY) specializes in this niche by providing more than 5 million sellers a platform to market their wares on. It is a place where customers can purchase an anniversary gift with their wedding date engraved, creative decorations, or a necklace bearing their unique name.

While Amazon is perceived by many as soulless, Etsy's mission is simple: "To Keep Commerce Human." This purpose was on full display when the COVID pandemic required people everywhere to begin wearing masks. Instead of buying generic face coverings on Amazon, consumers ordered artistic masks on Etsy allowing them to express their personality, even with a half-concealed face. 

Hand Crafted Goods

IMAGE SOURCE: GETTY IMAGES

The mask boost is over, what's next?

During the COVID-19 pandemic, Etsy's core market was still handmade or customizable goods, but masks were a boon to revenue. Face coverings contributed 7% of 2020 gross merchandise sales (GMS). With the pandemic well into its second year and most people already having purchased masks, masks are less in demand. This effectively eliminates a category that generated $743 million dollars in GMS during 2020. What's next for Etsy? Converting those new pandemic customers into active buyers. Etsy hasn't just met this goal; it's crushed it.  

In Etsy's second quarter which ended June 30, active buyers were up 50% to 90 million compared to the same quarter last year. Habitual buyers -- customers with six purchasing days and at least $200 spent in 12 months -- grew 115%. This drove revenue growth of 23% which is especially impressive considering the tough 2020 Q2 comparison of 137% growth. Service revenue led the way at 38% growth. This exciting segment expresses Etsy's optionality beyond its core platform. 

Advertising for sellers across the web

In 2020, Etsy introduced offsite ads. This initiative advertises products on sites like Google, Facebook, Instagram, and Pinterest. Interestingly, sellers with more than $10,000 in annual sales are required to participate, giving Etsy a 12% future sales cut. Shops that do not earn as much can still opt-in for a 15% fee. As GMS and buyers increase, more shops will meet the threshold to be enrolled. A larger product base to advertise will cast a wider net and attract more customers. Etsy is creating an advertising flywheel that will continue gaining momentum. 

As noted during its second-quarter conference call, gross margin benefits from ads. Since it was introduced in May 2020, gross margin increased by 10% to the low 70% range. An increased gross margin contributes to Etsy's free cash flow, allowing it to pile up cash for acquisitions or other business opportunities. 

Expanding its reach in different markets

While Etsy built its handmade goods platform, it acquires others to create a "House of Brands." In June, Etsy acquired Elo7 and Depop for $217 million and $1.6 billion respectively. Elo7 is known as the Etsy of Brazil; acquiring it gave Etsy a strong Latin American presence. Depop is a deviation from Etsy's core market; it runs an online fashion resale marketplace. Both acquisitions were primarily paid using cash, indicating Etsy's preference to avoid share dilution to fund deals.

Before being acquired, Depop was growing its revenue by more than 100%. Factor in a U.S. fashion resale market that's projected to double in five years to $77 billion and 90% of users are just reaching employment age (under age 26), Etsy made a strong acquisition. If fashion resale proves more than a fad, shareholders will be rewarded handsomely. 

Reverb is also under Etsy's roof, a platform for selling new and used musical instruments and accessories. Etsy's 2021 focus for Reverb is personalization, a niche Etsy knows well.  

Ready to rise again?

Etsy shares have been stuck in a range from $170 to $230 most of this year. This comes after a strong 2020 performance where its stock price nearly quadrupled. The stock price rise was not multiple expansion, as standard valuation metrics have either stayed the same or come down. 

Metric Current 9/30/20 9/30/19 9/30/18
Price to Earnings Ratio 62 68 69 80
Price to Sales Ratio 14 12 10 12

SOURCE: MACROTRENDS

When Etsy reports its earnings on Nov. 3, keep an eye on what Etsy is doing with its new acquisitions. This will be the first quarter where both companies are fully integrated, so investors should gain insight into Etsy's plan for them.

Lastly, the stock is entering earnings season with relatively low expectations. Any upward revenue surprises or active buyer growth could send shares rocketing higher. Additionally, growth in active and habitual buyers could translate into a strong holiday season. Growth investors should consider adding Etsy to their portfolio so it has a chance to compound for many years and reap the benefits of its acquisitions.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.