The past several months have been rough for high-growth stocks, many of which lost their luster as inflation, rising interest rates, and other macro headwinds drove investors toward more conservative investments. However, that relentless sell-off has also reduced the valuations of some well-run companies to more reasonable levels for long-term investors.
One of those beaten-down growth plays is Etsy (ETSY -0.38%), the online artisan marketplace that saw its stock plummet more than 75% after hitting an all-time high last November. I'll explain why investors should tune out all the near-term noise and buy this out-of-favor stock today.
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Why did the market turn against Etsy?
Investors abandoned Etsy over the past seven months for three simple reasons. First, it grappled with slower growth and challenging year-over-year comparisons in a post-lockdown market. Etsy's growth had accelerated during the pandemic as more people shopped online, and its growth was amplified by stimulus checks and brisk sales of handmade masks. Its revenue was also boosted by three acquisitions: musical instruments marketplace Reverb in 2019, U.K.-based fashion resale marketplace Depop in 2021, and Brazilian artisan marketplace Elo7 in 2021.
However, Etsy's growth cooled off as soon as the pandemic-era tailwinds waned and it lapped its acquisitions. Revenue surged 111% in 2020, but only rose 35% to $2.33 billion in 2021. Analysts expect its revenue to increase just 9% to $2.54 billion this year.
Second, Etsy's gross and adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization) margins declined in 2021 and the first quarter of 2022 as it generated a higher mix of lower-margin revenues from Reverb, Depop, and Elo7. As a result, analysts expect its earnings per share (EPS) to tumble 27% this year.
Lastly, Etsy's stock got overheated last year. At its all-time high last November, its stock was valued at 120 times estimated earnings and 15 times projected revenue for fiscal 2022. Those frothy valuations were arguably impossible to sustain as interest rates rose.
Why should you take a second look at Etsy?
Etsy faces a near-term slowdown, but many of its headwinds should be temporary. Right before the pandemic started, a survey by The Harris Poll found that 75% of American shoppers preferred to give unique gifts during the holidays, and that approximately two out of five millennial women preferred to receive handmade gifts.
Etsy should profit from that secular shift toward custom and handmade products -- which has likely been indirectly driven by the growth of Amazon (AMZN -0.33%), superstores, and other mass retailers. Etsy's takeover of Depop, which primarily sells secondhand clothing to shoppers under the age of 26, also gives it a firm foothold in the growing gen Z market.
These niche strengths should shore up Etsy's defenses against Amazon, which unsuccessfully tried to topple Etsy with its Handmade marketplace over the past seven years, as well as other online retailers. Moreover, Etsy's engagement rates also continue to rise even as it faces a near-term slowdown: 49% of its shoppers made two or more purchases in 2021 compared to just 41% in 2019.
Etsy still has plenty of room to expand overseas to offset a potential recession in the U.S. The company generated 43% of its gross merchandise sales (GMS) outside of the US in 2021 compared to just 36% in 2019, and it's gradually expanding into higher-growth e-commerce markets like Latin America and Southeast Asia.
Based on those longer-term catalysts, analysts expect Etsy's revenue and EPS to rise 19% and 46%, respectively, in 2023 after it laps its difficult year-over-year comparisons throughout 2022.
We should take those estimates with a grain of salt, but they suggest Etsy now trades at just 29 times forward earnings and less than four times this year's sales. Those ratios aren't dirt cheap yet, but they're certainly more sustainable than its nosebleed valuations from last November.
A good growth stock to buy and forget
Etsy could remain out of favor this year as investors fret over its near-term slowdown. However, it's carved out a defensible niche in the growing e-commerce market with its focus on handmade and unique products, and it should continue to grow for years to come. In short, investors who ignore the near-term volatility and accumulate some shares of Etsy at these prices could reap big rewards over the long term.
