The Federal Reserve's ongoing moves to raise interest rates in order to curb rising prices across the economy have no doubt had a major negative impact on equity markets. Consequently, some of the top growth stocks of the past several years have been crushed this year, as investors sour on high-multiple stocks in favor of safer companies they believe will do well in a potentially difficult economic environment.
So it was surprising to see that the market seemed to love Etsy's (ETSY -0.86%) second-quarter results, as the stock soared over 26% in the three weeks following the announcement. But the online marketplace's shares are still down 52% (as of this writing) in 2022. Is now the time to ditch the stock?
Look closer at the Q2 numbers
During the second quarter, Etsy's gross merchandise sales (GMS), the value of items sold on its various platforms, declined 0.4% year over year. But the company was still able to increase revenue 10.6% to $585 million. And due to higher employee head count, net income fell 25.6% compared with the prior-year period. Both the top and bottom lines exceeded Wall Street forecasts, which explains the stock's positive reaction following the news.
Etsy's take rate, the amount of revenue the business records as a percentage of GMS, jumped to 19.3% in Q2. This can be attributed to increasing the fee charged to sellers (from 5% to 6.5%), as well as the acquisitions of adjacent marketplaces Depop and Elo7. Additionally, Etsy Ads, an increasingly valuable tool for sellers, is showing remarkable strength.
It wasn't all positive news, however. As of June 30, Etsy counted a total of 93.9 million active buyers and 7.4 million active sellers, both of which showed sequential declines compared with Q1 2022, a rare occurrence for the once-booming e-commerce business. Consumers could be doing more in-person shopping. Also, because the items Etsy sells skew toward consumer discretionary purchases, a weakening economy may be to blame for the drop-off in active users.
Etsy's massive growth opportunity
Both Etsy's declining user base and soaring inflation are certainly important headwinds the business must grapple with. But I think the company's long-term outlook is still strong. According to the management team, led by CEO Josh Silverman, Etsy's total addressable market in its seven core geographies (U.S., U.K., Canada, Germany, Australia, France, and India) is $466 billion for relevant merchandise categories in online retail. And based on the company's 2021 GMS of $13.5 billion, the main Etsy marketplace only commands a 2.6% share, leaving plenty of expansion opportunity.
As consumers continue seeking out differentiated products and shopping experiences (a survey revealed that 88% of Etsy buyers found items on the site that they couldn't find anywhere else), focus more on supporting small businesses, and keep wanting to show off what they've purchased on social media, Etsy's prospects remain bright.
Total e-commerce sales in the U.S. now represent about 14% of overall retail sales, up substantially from just five years prior. This underlying secular trend might have been somewhat distorted by the pandemic, but e-commerce's penetration of the overall retail sector is going to keep rising in the decade ahead. And Etsy is positioned well to benefit from this. As the company's GMS, revenue, and net income rise over time, the stock will likely follow.
Consider the stock's valuation
After hitting an all-time high of $296.91 in November last year, Etsy's stock has fallen precipitously, down 65% from the peak. This translates to a price-to-sales ratio of 37 and a price-to-earnings ratio of over 6, both significantly below the company's trailing five-year averages. It's probably safe to say that the pessimism surrounding the stock is through the roof right now.
But if we zoom out and focus on the bigger picture that I just discussed, Etsy is still a fantastic enterprise, despite the shrinking user base that is currently plaguing the business. From 2016 through 2021, Etsy's revenue has increased at a compound annual growth rate of 44.8%, while operating income has absolutely skyrocketed from $18.7 million to $502.4 million during the same time.
To be clear, the monster gains registered in the past probably won't repeat in the future. Nonetheless, I still think shareholders should continue holding Etsy stock. In fact, it might even be a good idea to buy more.
