After closing at an all-time high price of $297 in 2021, Etsy's (NASDAQ: ETSY) stock price has fallen by almost two-thirds to $107. Eager investors might be considering buying the stock today. But should they? Let's explore this further.
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The near term is unexciting for Etsy
When the pandemic hit in 2020, e-commerce platforms like Etsy benefited as users relied on online shopping for daily necessities. Sales transactions rose, propelling Etsy's revenue up by 111% in 2020 and another 35% in 2021. Investors even predicted that online sales would continue to grow at rates higher than the pre-pandemic period in perpetuity.
But that did not happen. As global economies reopened, consumers returned to physical shopping, and e-commerce companies -- including Etsy -- suffered. For example, Etsy's gross merchandise sales (GMS) declined by 4% in the fourth quarter of 2022 and 1% for all of 2022. Comparatively, GMS rose 107% in 2020 and 31% in 2021.
Moreover, investors expecting a quick turnaround in Etsy's performance would have been disappointed when the company guided for GMS of $2.95 billion to $3.15 billion in the first quarter of 2023. The higher end of this guidance was lower than that of the same period last year ($3.25 billion).
On a slightly positive note, Etsy's revenue grew by 10% in 2022 as the company raised its take rate. Still, such a measure to increase revenue is unlikely to be sustainable over the longer term. So, unless the e-commerce company can turn around the GMS growth trajectory, investors can expect revenue growth to remain sluggish or even negative.
But there are still plenty of ways for Etsy to grow
By now, it is evident that the near term does not bode well for Etsy. But the long-term opportunities remain plentiful. Etsy estimates that its target addressable market (TAM) is worth $466 billion. As of 2022, it has only a 2.5% market share of this TAM. It can grow many times its current size and still have plenty of untapped potential.
Specifically, Etsy can continue to expand in its existing markets by attracting new buyers and increasing buyers' spending over time. By focusing on tailored offerings and one-in-a-kind products, the e-commerce platform differentiates itself from its peers -- which traditionally focus on selling mass-produced, standardized goods. This strategy has helped it remain relevant in the competitive online shopping environment to date, and will likely continue to do so.
Beyond that, Etsy is building its presence in overseas markets such as Germany, India, and more. It also counts on mergers and acquisitions to capture new markets and user groups. For example, it spent slightly below $2 billion in 2021 to acquire Elo7 and Depop.
In short, there are still plenty of levers that Etsy can pull to keep its growth machine spinning. And with a cash balance of $1.2 billion and a solid cash cow generating north of $600 million in annual free cash flow, it has a lot of firepower at its disposal.
So is Etsy stock a buy?
So there is a tussle between short-term weaknesses and solid long-term prospects for Etsy. Still, for investors willing to invest for the long run (five years at least), there is one more hurdle to overcome. And that's valuation.
The idea is simple. Investors should not overpay for Etsy even if they are optimistic about its long-term growth opportunities. As of this writing, Etsy is trading at a price-to-sales (P/S) ratio of 5.6, which is lower than its five-year average of 10.7.
But Etsy still trades at a significant premium compared to other e-commerce companies like Amazon and Alibaba, with P/S ratios of 2.0 and 1.7, respectively.
In short, while Etsy's stock price today is on the lower end of its historical spectrum, it is not a screaming buy. Etsy's bulls may consider buying a small position today and add to that position over time if the stock becomes cheaper.
