Etsy (ETSY 2.86%) investors had a rough 2022. The stock underperformed a weak market on fears about a short-term growth slowdown as consumers shifted spending away from e-commerce channels. Wall Street was also concerned that Etsy might not be able to quickly pivot toward profitability.
But smart investors can look past those short-term concerns as they judge the big-picture opportunities for the e-commerce platform. With that approach in mind, let's look at a few factors that suggest this growth stock has a bright future.
1. Growth is holding up
The headline takeaway for many investors in 2022 was that Etsy is done growing. The value of sales on its platform fell 3% in the most recent quarter, which ended in late September.
Look a bit closer, though, and you'll see that Etsy is performing well in a difficult selling environment. Peer eBay (EBAY 0.61%) reported an 11% volume decline for the same period. Strip out the impact of currency exchange rates, and Etsy grew sales 1% compared to eBay's 5% drop.
The company is also doing a better job holding on to most of the new buyers that found its platform during the pandemic. The buyer pool shrunk by just 2% in the third quarter. And eBay's comparable-sales figure was down 11%. "We believe our sustained performance is a testament to Etsy's unique position in e-commerce," CEO Josh Silverman said in early November.
2. Pricing power is there
Etsy isn't impressing anyone with its bottom-line financial results right now. Its net loss through the first three quarters of 2022 was a brutal $803 million. That figure is heavily influenced by a one-time impairment charge, though.
Looking at the continuing operations shows a stronger business that might have solid pricing power. Gross profit rose 11% in the most recent quarter even though sales volumes were flat. That boost was supported by rising seller fees, which landed at 20% of sales in the third quarter; eBay's comparable figure is 13%.
The platform has a shot at being highly profitable if it can maintain such a high take rate, and the key to lifting that figure is for the company to provide more services to sellers even as its buyer pool grows. Management is currently reinvesting most of that extra cash into the platform with an eye toward achieving that result.
3. A proven business model
Etsy's middleman-selling approach has many attractive characteristics that support positive shareholder returns. The company isn't taking on inventory risks like a retailer would. Its fees power strong cash flow, too, which can start flowing more toward shareholders once the company slows its pace of growth investments.
"We love our business model," Chief Financial Officer Rachel Glaser said, pointing to Etsy's strong, adjusted profit margin.
ETSY operating margin (TTM); data by YCharts. TTM = trailing 12 months.
Investors have a chance to own that attractive business model at a discounted price today. Shares are going for about 7 times annual sales while the price-to-sales ratio was nearly 12 just a year ago.
Sure, eBay stock is much cheaper at 2.5 times sales. And the wider e-commerce industry could see further disruptions in 2023 if a recession depresses consumer spending.
But smart investors know that cyclical downturns like that are a fixture in industry that don't threaten the long-term bullish thesis. Etsy faces risks, like any business. But it has a good shot at producing much higher earnings and cash flow over time.
