E-commerce is a broad industry. There are companies directly involved with the process, and facilitators like Shopify (SHOP 0.07%) and Etsy (ETSY +0.40%). I believe facilitators make better investments, as they usually have better margins and insulation against what is or isn't in style.
However, Shopify and Etsy have been terrible investments in 2022 after crushing the market in the past two years.
With that kind of sell-off, many investors may wonder if this is a solid entry opportunity, as both are still category leaders. So let's dig into their most recent financial results and see which is the better buy in today's tumultuous market.
A one-time effect influenced Etsy's growth
First, a quick business overview: Shopify provides the software necessary to run an e-commerce store, including inventory management, shipping logistics, payment processing, and a website. In exchange for using its software, Shopify charges its customers a flat monthly fee and takes a slice of each transaction.
Etsy is similar, except it is focused on extremely small operations that usually sell custom or hand-made goods. Through Etsy's marketplace, sellers can list their items, and Etsy takes a slice of each transaction in return.
Both businesses saw a massive boom during the pandemic. However, each is coming up against difficult comparisons now. For example, in the second quarter, Etsy's revenue rose 11% versus a gross merchandise sales (GMS) decline of 0.4%. This disconnect is due to Etsy raising its transaction take rate from 5% to 6.5% at the beginning of the quarter -- which caused some sellers to strike for a week.
NYSE: ETSY
Key Data Points
Shopify's revenue grew slightly faster at a 16% clip, with gross merchandise volume (GMV) rising 11%. For Shopify, its primary growth driver was its Merchant Solutions segment, which was up 18% year over year due to more customers adopting more services from Shopify.
Shopify is the clear winner regarding growth, as its growth came organically versus Etsy's growth primarily coming through a one-time increase. Etsy can only push its sellers so far before an alternative arises.
Winner: Shopify
Shopify is spending like it's going out of style
Moving to the bottom line, it's clear: Shopify is spending heavily to promote and innovate its platform. Its expenses rose tremendously compared to modest 16% revenue growth:
| Shopify Q2 Expense YOY Growth | ||
|---|---|---|
| Sales and Marketing | Research and Development | General and Administrative |
| 62% | 89% | 67% |
Source: Shopify. YOY = year over year
As a Shopify investor, I don't like seeing this kind of growth-and-spending disconnect. Although it was profitable in 2021 because of COVID effects, it no longer holds that designation. To partially remedy this and reduce expenses, Shopify laid off about 10% of its workforce. CEO and co-founder Tobi Lütke blamed himself for the overhiring mistake, as he expected the COVID e-commerce gains to be permanent rather than revert to the standard adoption curve.
Etsy's earnings aren't nearly as messy. The company is profitable, although its net income fell 26% YOY. However, its adjusted EBITDA margin rose from 26% last year to 28% this year, so its cash flow metrics are improving -- a positive sign for investors. Still, Etsy's operating expenses rose at a 17% clip, which is still concerning to me, although not nearly as much as Shopify's expense-growth rate.
Etsy maintained its profitability and is controlling its expenses relatively well, unlike Shopify. There's no real argument in the competition for the more robust bottom line.
Winner: Etsy
The future
Perhaps the most critical segment of the overall comparison is what the future looks like for both businesses. After all, this is what will drive any future stock-price movements.
Etsy's most significant growth catalyst is its booming advertisement business. Year to date, seller ad budgets have increased by 80% -- growth that flies in the face of conventional wisdom about advertising during recessionary times. Since Etsy controls the ads, it makes money both from ad sales and increased revenue, so it is a critical initiative for the company.
Shopify has many irons in the fire, but one that steers it from its roots is its point-of-sale (POS) offering, which grew 47% YOY. POS systems are utilized in brick-and-mortar settings, not e-commerce. However, if Shopify can establish its brand in this space, it holds significant revenue potential.
NASDAQ: SHOP
Key Data Points
Additionally, Shopify Plus (which targets larger companies) signed Asics and HP during the quarter. Shopify's improving logistics capabilities and international expansion were likely a big reason why large brands like these two signed, and these improvements will deliver significant value to existing customers as well.
Shopify has a bigger future in front of it than Etsy, but this broad vision is also what is causing Shopify to increase its expenses rapidly.
Winner: Shopify
Which stock should you buy?
Although the tally is two points for Shopify and one for Etsy, there's a lot more to the picture for both companies. Etsy's stock trades for 6.5 times sales, lower than Shopify's 9.1 times, despite having much better margins. This valuation discrepancy is due to investor sentiment, as many people believe Shopify has a huge growth runway.
Shopify's runway is likely larger, but if it fails, the downside will be much lower than Etsy's. If you're invested in these companies for the next three to five years, it's hard to ignore Shopify's potential, but its business has shown some weakness lately.
The choice between which stock is better ultimately boils down to your risk tolerance. Etsy is the lower-risk play, but it comes with limited upside. Shopify is the exact opposite. Nevertheless, both are solid businesses, and investors should choose accordingly.
