As e-commerce has given back some of the ground it took from physical stores this past year, e-commerce stocks have suffered, and Etsy (ETSY 2.44%) is no exception. In some metrics, like total value of goods sold via its marketplace, Etsy has contracted in 2022.

But the business is still being run like a growth business. CEO Josh Silverman talked on the last earnings call about a large backlog waiting to be addressed of new projects that can fuel future expansion. And that's part of the reason Etsy stock has been clobbered by 50% in 2022: Growth businesses are being punished.

Also, one hangup some investors have with growth stocks is stock-based compensation. Here too, Etsy is no exception, as it pays stock-based comp to its employees. Should investors be worried?

A potential shareholder-diluting activity

Etsy has paid out $166.5 million in stock-based comp through the first nine months of 2022. Even for a company that's generated $1.76 billion in revenue and free cash flow (FCF) of $384 million over that same span of time, it's a significant sum.

What's the big deal with stock-based compensation? For existing shareholders, it dilutes their ownership of the business, especially their claim on any profits on a per-share basis. The effect is a smaller slice of the pie. As long as the pie is growing, many tech companies are able to hide the effects of this dilution. But with business growth slowing this year, stock-based comp is being put under a microscope, as it can have a much more dramatic impact on shareholder value creation when a business suddenly stalls out.

This helps explain why many investors have grown sour on Etsy stock. Revenue growth has decelerated (up just 9% through the first nine months of the year). Net income has swung to a net loss (thanks to a noncash expense related to the write-off of last year's acquisition of Depop and Elo7). And FCF growth is also only up 8%, as the company invests in things like personalized search to keep shoppers engaged.

Shares currently trade for 24 times trailing-12-month free cash flow, an elevated price that still reflects a lot of optimism in where this e-commerce marketplace is headed.

Don't miss this important metric

While stock-based comp is a bit elevated right now at Etsy, the company is quietly doing more than enough to offset dilution. Through the same nine months of 2022, Etsy has repurchased $275.3 million worth of stock, more than offsetting the $166.5 million doled out to employees.

The net effect? Etsy's total outstanding share count was reduced by 14% over the 12-month stretch that ended in September. Rather than shrinking the slice of the pie for each shareholder, Silverman and company have actually been growing each slice for long-term investors.

On a per-share basis, Etsy's FCF growth has been stunning since Silverman took over in 2017:

ETSY Free Cash Flow Per Share Chart

Data by YCharts.

Of course, with profit margins taking a hit this year, the question becomes whether Etsy can sustain its share repurchase program. I believe it can. Though e-commerce has petered out as of late, online shopping is still a secular growth trend that could pick up pace again in 2023. And Etsy is a highly differentiated marketplace, offering unique and handmade items that connect buyers and sellers in a personalized online experience. As Silverman and the top team's heavy investment of cash starts to pay off, I expect to see profit margins rebound.

Don't get too hung up on Etsy's "expensive" valuation and stock-based comp. Silverman has proven he knows what he's doing with this business, and is offering a healthy balance of growth and profit generation -- with a lot of that profit being sent in the direction of investors via an oft-overlooked share repurchase program. This remains a top-notch e-commerce stock to hold for the long haul.