The most recent consumer price index reading from the U.S. Bureau of Labor Statistics put inflation at 9.1% in June. Inflation hurts e-commerce stocks as demand for their goods will likely decline as the consumer's purchasing power dwindles. 

With inflation taking center stage this year, Etsy (ETSY -2.17%) has dropped nearly 72% from its all-time high. So should investors now be bullish or bearish on the stock? Motley Fool contributors Jamie Louko and Parkev Tatevosian present both sides of the argument.

Person unpacking a box.

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Bull case: Etsy is still catching eyes

Jamie Louko: While shares of Etsy might be spectacularly off their all-time highs because of inflation and recession fears, they are also giving long-term investors a bargain for the company today. The stock trades at 23 times free cash flow, which is substantially lower than past valuations. In fact, this is near Etsy's lowest valuation over the past five years. A lot of pain seems to be priced into the stock, and the good news that has recently emerged has seemed to go unnoticed. 

The number of Etsy app downloads has risen higher in recent months, putting a wet blanket on the current idea that demand is dropping for Etsy's handmade goods due to rising inflation. According to AppFigures, Etsy's app was downloaded roughly 2.2 million times in May 2022 -- almost as many downloads as it saw in December 2021. 

In other words, despite the winds pushing against Etsy, it is currently seeing nearly record-high downloads, showing the company's resilience, even during a bad economic period.

Additionally, Etsy has recently seen continued demand for its products. In Q1 2022, the company had over 95 million active buyers, which jumped 5% compared to Q1 2021 -- one of Etsy's best quarters as a company. The company also saw a year-over-year revenue increase of 5.2% in Q1, which helped free cash flow reach $50 million over the same period. 2022 will bring some tough comparable quarters because of its boost in activity in 2021, so the fact that Etsy is even growing year over year is quite impressive. 

For long-term investors who can look through an uncertain short term, Etsy might be for you. This business is the top dog when it comes to handmade goods, and it is proving that through sustained demand -- even in a bad economic environment. When the cloudy skies inevitably pass, Etsy could see improving demand and thrive over the long term.

Bear case: Etsy is past its peak

Parkev Tatevosian: My bear case for Etsy centers around the headwinds from the economic reopening. Etsy experienced a surge in revenue because of the emergence of COVID-19. The e-commerce company is home to creative sellers who cleverly started making and listing custom masks on the platform. Of course, masks were in high demand earlier in the pandemic when it was mandatory to wear them. 

As a result, revenue increased by 111% for Etsy in 2020. Similarly, operating income jumped from $89 million in 2019 to $424 million in 2020. That was great news for investors who bought Etsy before the outbreak. However, if you are considering buying now, it is a more significant risk. Etsy's revenue and profits are at peak levels and reversing as economies reopen.

ETSY Operating Income (Quarterly) Chart

ETSY Operating Income (Quarterly) data by YCharts

In its most recent quarter, which ended on March 31, revenue increased by just 5%. Meanwhile, operating income is trending downward. There is no telling how far revenue and profits will slow down as consumers have more choices of where to spend their money. To make matters worse, rising inflation has forced the Federal Reserve to aggressively raise interest rates, slowing economic growth and increasing the risks of a recession in the U.S. (Etsy's primary market).

If the economy is to enter a recession, transactions on Etsy's platform could take a meaningful hit as most of the products sold are discretionary and non-essential. These are some of the first things consumers stop buying when their incomes fall. 

Who wins out?

The waning pandemic and increasing economic uncertainty are certainly taking their toll on e-commerce stocks, but some investors might see this as an appealing buying opportunity. For this to be a worthwhile investment, however, your time horizon should be long, likely five years or more. With this uncertain economy, Etsy could be volatile over the short term. 

Given its low valuation, however, the pain seems to be fully priced in. With that, investors might want to consider adding this niche e-commerce leader to their watch list, if not their portfolio.