This has been an ugly year for e-commerce stocks. Many companies in the industry have seen their share prices decline far in excess of the broad market.
But the silver lining for savvy investors is that this sectorwide tumble offers many opportunities to pick up shares of leading e-commerce companies like Shopify (SHOP -2.37%) and Etsy (ETSY 0.49%) at a discount. But which of the two is a better buy now?
Image source: Getty Images.
Shopify vs. Etsy's business model
While both Etsy and Shopify are e-commerce companies, they have significantly different business models. Etsy operates an e-commerce marketplace that focuses on matching sellers of craft and vintage goods to buyers. For entrepreneurs and small businesses, it provides a popular platform for them to sell their merchandise globally. For buyers, it brings together a vast array of one-of-a-kind items that can be hard to find elsewhere. Etsy charges sellers fees for transactions, payments processing, and advertising, among other services.
Shopify, too, aims to help entrepreneurs succeed by making it easier for them to sell their products globally. But instead of managing its own marketplace, it provides users with e-commerce tools and services like online storefronts, a payment platform, shipping, and more. It operates under the software-as-a-service (SAAS) model, making it seamless for merchants to sign up and make payments.
Unlike Etsy, Shopify is not directly responsible for customer acquisition. Merchants need to attract their customers using the tools Shopify provides them. But the benefit of such an arrangement is sellers completely own their customers while Shopify acts mainly as an infrastructure provider.
The difference in their business models is evident when comparing the take rates of both companies. In the second quarter of 2022, Etsy generated $585 million in revenue by enabling $3.0 billion in gross merchandise sales on its platform. On the other hand, Shopify generated $1.3 billion in revenue on the back of gross merchandise value of $46.9 billion.
In other words, Etsy's take rate was 19.3% compared to Shopify's 2.8%. The gap in their take rates partially explains why Etsy was profitable during the quarter, while Shopify reported a sizable loss.
Which company has better prospects?
The e-commerce industry is undergoing tremendous pressure as shoppers are largely returning to their pre-pandemic habits. On top of that, high inflation, recession fears, and geopolitical tensions have impacted consumer spending. Suffice it to say that both Etsy and Shopify will continue to face challenges in the coming months.
However, over a longer time horizon -- five to 10 years -- both companies have enormous opportunities to grow their businesses. Etsy's management estimates it has tapped less than 3% of its total addressable market of $466 billion.
Similarly, Shopify (despite its size) still has plenty of room to grow. Its platform facilitates less than 2% of U.S. retail sales, and the company is actively expanding into international markets -- global e-commerce sales reached $4.9 trillion in the year 2021. Shopify could grow by a factor of 10 and still not exhaust its opportunities.
Both companies have historically grown at high rates. In the last five years, Etsy grew its revenue more than sixfold, from $365 million to $2.3 billion. Shopify did even better, growing revenue almost 12-fold from $389 million to $4.6 billion.
In short, both companies have tremendous growth runways ahead of them, but based on past performance and the broader appeal of its services, Shopify seems to have the upper hand.
A short discussion on valuation
The two e-commerce leaders' stock prices fell precipitously over the last 12 months. As of this writing, Shopify is down about 80%, while Etsy is off around 55%.
Unsurprisingly, both companies are trading at much cheaper valuations than their historical averages. For example, Shopify's price-to-sales ratio (PS) is 7.0 as of writing, far below its five-year average of 29.8 and nearly its lowest showing in that period. Etsy is in a similar boat trading at 5.9 sales, while the stock has averaged 10.6 in the last five years.
Shopify may seem like the bigger bargain while it trades at a steeper discount to its historical average, but remember Etsy is actually profitable. Given the strong growth prospects for these companies, both stocks enjoy a premium to the broad market.
A profitable growth stock vs. a loss-making hypergrowth stock
Overall, there isn't a clear winner between these two e-commerce leaders. The better choice for you will depend on your individual investing philosophy and risk tolerance.
On one hand, Etsy is already profitable with a sizable growth runway, even though its track record has lagged that of Shopify over the last five years. On the other hand, Shopify is the pricier stock with a spottier bottom-line record.
Investors looking for investments that are more balanced between growth and profitability should go with Etsy, while those looking for higher-risk, high-reward plays may prefer Shopify.
