Etsy's (ETSY 3.29%) share price has plummeted from the lofty highs it commanded a year ago. The e-commerce company reported a tepid first quarter, with revenue advancing by just 3.5% year over year. With more shoppers returning to physical stores, momentum has slowed significantly, which has contributed to the stock's 74% drop from recent highs.
Investors might have gotten a little too enthusiastic about Etsy's long-term prospects, when the stock traded at a valuation of over 100 times earnings per share during the pandemic. Etsy was never going to sustain triple-digit levels of growth in gross merchandise sales, so a correction by the market should have been expected.
On the other hand, the stock might be oversold, since it's also not reasonable to assume that 3.5% growth is the new normal for this emerging e-commerce brand. Let's look at two reasons why the stock could be a steal right now.
1. The stock offers better value
The sudden acceleration in growth in 2020 followed by a quick deceleration once people returned to in-store shopping has created a confusing picture as to Etsy's normalized growth rate. However, nothing has changed Etsy's long-term prospects over the last three years.
The broader opportunity in e-commerce is still intact. E-commerce sales now make up over 14% of total retail sales in the U.S., based on the U.S. Department of Commerce's first-quarter estimate, compared to about 10% at the end of 2019.
The only thing that has changed is Etsy's valuation. The stock now trades at a price-to-earnings (P/E) ratio of 29, which is down from over 50 times earnings in 2019. In other words, investors can buy a share of the company's profits for almost half the price.
ETSY PE Ratio data by YCharts.
2. Management has a knack for improving margins
Etsy's current valuation looks cheap considering long-term growth expectations. The current consensus estimate has Etsy growing earnings at a compound annual rate of 39% over the next five years.
One way Etsy can achieve that higher rate of earnings growth is through increasing margins. Over the last five years, operating margin has improved from breakeven to 17%. There is one reason to expect this trend to continue over the long term.
E.TSY Operating Margin (TTM) data by YCharts.
Management has been acquiring complementary marketplaces where it can improve the business's performance. For example, in the first 18 months after acquiring Reverb, a leading marketplace for used music instruments, in 2019, Etsy improved Reverb's gross margin from 33% to over 50%.
Etsy made two more acquisitions in 2021. It purchased Latin American marketplace Elo7, expanding Etsy's footprint to the fast-growing Latin American e-commerce market. The other was the popular secondhand clothing marketplace Depop.
Management is already starting to implement better marketing tactics at Depop to allow that business to realize its full potential. In fact, Depop has emerged as a popular marketplace despite hardily utilizing any marketing products, so there is a ton of potential to accelerate growth.
The opportunity with these acquisitions could be game-changing for revenue growth and margins. Depop and Elo7 are currently not contributing a profit to Etsy but that will change. Depop alone could grow into a highly valuable business; the secondhand clothing market is estimated to more than double to $218 billion by 2026. The opportunity across Etsy's entire business is obviously much larger, which further builds the case for buying the stock.
The combination of a lower valuation, along with the long-term upside potential of management's "House of Brands" strategy, makes the stock a compelling buy right now.
