With the stock market taking a massive hit this year, many high-quality businesses have gone on sale. Prudent investors can either choose to add to their existing holdings or finally buy shares in a company that has long been on their watch list. But one thing is for certain: Now is not the time to abandon your investing strategy.
I'm looking at a business that provides its customers with a valuable service, possesses outstanding financials, and sells for an attractive valuation. If there was only one stock I could buy right now, it would be Etsy (ETSY -0.86%). Let's take a closer look at why.
Valuable for buyers and sellers
The e-commerce marketplace for unique and handcrafted goods provides a significant value proposition for its user base, and this is critical for investors to know. A 2020 survey of Etsy shoppers showed the vast majority (88%) of users say the site offers items that they can't find anywhere else. For many of the company's 95.1 million active buyers as of the first quarter, Etsy is an irreplaceable shopping destination. And over time, the average active buyer tends to spend more on the platform. Consumers are increasingly interested in supporting small businesses, a trend that benefits Etsy's network of sellers.
From the sellers' perspective -- 7.7 million of them -- Etsy is a mission-critical partner that helps these entrepreneurs run their small businesses and reach a global audience. Not only does Etsy allow shoppers to discover new items, but the platform provides ads, payment processing, and shipping tools. This broad array of services is why I don't think the recent fee hike for sellers will have much of a negative impact.
With more buyers coming onto the platform, Etsy becomes more valuable to sellers. And the opposite is also true, as having more sellers means a wider selection of merchandise. This is a classic network effect, a competitive advantage that will keep supporting Etsy far into the future.
Superb financial profile
Because Etsy doesn't own any inventory itself and simply facilitates transactions between buyers and sellers, its business model scales incredibly well. From 2016 to 2021, the company's operating margin soared from 4.8% to 20.0%. Once the foundational investments have been made to develop the technology and infrastructure behind the marketplace, any additional transactions that take place are very profitable.
The company's capital-light business model is extremely attractive from an investment perspective. Etsy doesn't require much cash in the form of reinvestment in order to grow. During the first quarter of 2022, capital expenditures totaled just 1.6% of revenue. This means lots of free cash flow (FCF) is produced ($623 million in 2021) -- cash flow that can be used for other purposes.
Etsy uses some of its cash to pursue acquisitions. In recent years, it purchased Reverb, a marketplace for used musical instruments; Depop, a secondhand fashion site; and Elo7, known as the Etsy of Brazil. The goal is to create a "House of Brands" with products that cover broad categories.
Current valuation
While many loss-making, high-growth tech stocks have been getting hammered in recent months, Etsy produces cash, a holy grail for any enterprise. And yet its stock has still gotten crushed. As of this writing, shares boast a price-to-earnings ratio of only 24, its lowest level in about five years. It's safe to say investors have soured on this pandemic winner.
I know it's difficult right now, but it's important for investors to look at the bigger picture. Etsy's management believes the company's total addressable market is in the hundreds of billions of dollars, meaning there is still a huge growth runway ahead of the business. Even Wall Street is optimistic about Etsy's prospects as analysts are calling for revenue and FCF to increase at a compound annual rate of 14.5% and 16.6%, respectively, from 2021 to 2026.
Etsy has developed a differentiated platform that is desired by both its buyers and sellers. And the company is riding the broad secular growth of online shopping, a category that will continue to get bigger over the next decade. Couple this with fantastic financials, and Etsy stock looks like a solid buy today.
