It's been a rough start to the year for Etsy (ETSY 7.34%), to say the least. The online marketplace for unique handmade goods has shed 33% of its value in 2022 amid the broader stock market sell-off. And since hitting an all-time high of $296.91 on Nov. 24, the stock has dropped about 50%.
This e-commerce winner has certainly seen better days, and investors are now questioning whether it's a stock worth holding onto now. Let's dive into the bull and bear cases for Etsy to provide shareholders with some clarity that they desperately need.
What the bulls say
Etsy no doubt received a huge surge in demand during the height of the pandemic in 2020, and that has not slacked off completely. In the first nine months of 2021, the business registered growth in gross merchandise sales (GMS) and profit of 39.2% and 65.4%, respectively. While that's less than its respective GMS and profit gains of 101.1% and 210.7% in the first nine months of 2020, those 2021 figures are still outstanding -- indicating Etsy is not just a pandemic play.
Acquisitions have played a big role in its expansion strategy. In 2019, the business bought Reverb, an online marketplace for musical instruments. And just last summer, management decided to purchase Depop, a secondhand-fashion reseller, and Elo7, known as the Etsy of Brazil, to round out what CEO Josh Silverman calls a "House of Brands." Not only do these deals bolster Etsy's value proposition, but they also present the company with a $1.7 trillion global addressable market.
Because Etsy simply connects its 96 million active buyers and 7.5 million active sellers to facilitate transactions, it operates a capital-light business model. And this results in some stellar financial metrics. Over the past 12 months, it had a 73.3% gross margin and a 23.3% operating margin, both of which have shown remarkable improvements over the years. And the business is a cash cow, generating $584.4 million in free cash flow (on revenue of $2.2 billion) during the trailing-12-month period.
It's no wonder that bulls think Etsy looks like an unstoppable e-commerce stock for 2022 and beyond.
What the bears say
On the other hand, the bears can make a valid argument that Etsy's market-crushing 1,000% return over the past five years won't even come remotely close to being repeated in the years ahead.
The company's take rate -- that is, its revenue divided by GMS in any given period -- is set to decline. Those previously mentioned acquisitions of Depop and Elo7 are to blame. "The average take rate for our subsidiary businesses is lower than the Etsy marketplace's and was approximately 10% in Q3," Chief Financial Officer Rachel Glaser said on the third-quarter 2021 earnings call. This just means that the company will need to figure out additional value-added services to offer its users in order to extract higher fees, a move that could drive them away from the platform.
During the trailing 12 months, the largest (and fastest-growing) product category on Etsy was homewares and home furnishings with $4.2 billion of GMS, representing 32.6% of the company's total. While this does exemplify the broad range of merchandise sold on the site, this category in particular lends itself to a much longer replacement cycle by shoppers than, say, apparel or jewelry. And fewer transactions translate to lower revenue for Etsy.
Although Etsy is known to be a shopping destination for special and unique goods, we can't ignore the 800-pound gorilla when it comes to online shopping: Amazon. The tech giant launched Amazon Handmade in 2015 to serve the artisan community and compete directly with Etsy. It's hard to gauge its success so far, but Amazon could easily undercut Etsy when it comes to various fees that sellers pay, including to process payments and display ads.
Become a smarter investor
It's definitely a difficult exercise to do, but analyzing both sides of the argument for any stock you own or are interested in can reveal valuable insights about the business. And at the end of the day, that's what we as market participants are trying to figure out. Our goal should always be to become better and more informed investors.