One of my favorite quick and easy ways to get a feel for whether a growth stock may be considered a "value" or not is to compare its price-to-free-cash-flow (P/FCF) ratio with its annual sales growth rate. Anytime a company's sales growth comes in higher than its P/FCF multiple, that catches my attention, because it highlights a strong expansion rate at a reasonable price.
One such company is e-commerce specialist Etsy (ETSY -3.65%), with its P/FCF of roughly 31 and its annual revenue growth of 62%. At first glance, these figures look incredibly promising and make Etsy look like a screaming buy. However, during the third quarter, its year-over-year sales growth decelerated to 18%, leaving me to wonder -- has Etsy become a value stock?
Is decelerating growth here to stay?
Etsy will report fourth-quarter earnings on Feb. 24, and gross merchandise volume and quarterly sales growth will be of the utmost importance for investors to watch. When the pandemic began, the global acceleration in e-commerce pulled years' worth of Etsy's growth forward. As a result, the company posted triple-digit percentage sales growth in late 2020 and early 2021. But now, it's lapping those periods, which makes for tough comparisons.
Analysts expect to hear that sales in Q4 rose by only 11% to around $685 million, and Etsy's declining share price reflects the market's worries that the company's high-growth days are behind it.
However, gross merchandise volume per active buyer rose by 20% year over year in Q3 thanks to a higher average order value and increased order frequency, highlighting that its customer lifetime value metric is improving.
Furthermore, the upcoming earnings call will be Etsy's first with a full quarter's worth of information regarding its Reverb, Elo7, and Depop acquisitions altogether, making this report unusually important to long-term-minded investors.
Elo7 offers valuable exposure to the Latin American e-commerce market, while Depop is geared toward Gen Z, a younger demographic than Etsy's core user base. Even better, Depop operates in the apparel resale industry, which is expected to grow five times faster than the broader clothing market through 2025.
Ultimately, these decelerating sales growth figures show that the company's annualized revenue growth rate of 62% may be misleading due to its pandemic-aided spike. However, its P/FCF ratio is only 31, and Etsy could quickly outgrow this valuation should it continue posting 20% or higher gross merchandise volume growth for any extended length of time.
Etsy's plummeting price to free cash flow
This P/FCF of 31 is down from a 2021 high of roughly 75 -- a fall that reflects investors' concerns about Etsy's growth deceleration.
With this multiple down by more than half, and despite its slightly lower free cash flow generation, Etsy has begun trading at a level that's closer to value territory. However, the FCF figure in Etsy's upcoming earnings report will be pivotal as it laps 2020's Q4, which saw a massive $240 million in FCF.
Further clouding the picture around Etsy's valuable FCF generation is the simple fact that it is still integrating and investing in its Elo7 and Depop acquisitions, which will weigh on its margins for the foreseeable future.
Ultimately, Etsy may not be the blatant value stock that its P/FCF of 31 and annual sales growth of 62% make it appear to be -- but it still has an incredibly sound investment thesis for the long term. Thanks to its free cash flow margin of 26%, promising recent acquisitions, and strong organic growth through its existing customer base, now may be an excellent time to consider opening a position in Etsy or adding to one.
While decelerating growth and a slowdown in FCF generation might seem like a deal-breaker for one's investment thesis, I believe these figures represent how Etsy flourished at the onset of the pandemic -- rather than showing any genuine flaws within its current operations.