The pandemic was a boon for the e-commerce sector as consumers avoided physical shopping in favor of spending online. Etsy (ETSY 1.12%) benefited from this trend, posting monster growth in 2020 and 2021. Things slowed down last year, unsurprisingly, after consumers returned to their normal behavior.
Etsy shares have fallen 57% since the start of 2022 and 22% this year alone. So it's safe to say that investors are pessimistic about this e-commerce stock. But it's not all bad news. Here's why investors might still want to consider buying Etsy for their portfolios.
Positive results from the first quarter
Despite what Etsy's share-price performance might suggest, the business just reported what I think was a generally good quarter. Revenue of $641 million was up 10.6% year over year. But because gross merchandise sales (GMS) -- the amount of purchase volume occurring on Etsy's various marketplaces -- was down 4.6%, the revenue increase was driven by higher fees. The so-called take rate, which measures revenue as a percentage of GMS, was 21% in Q1.
In April of last year, Etsy raised the fee it charges its sellers. At first, this was viewed as a risky move that might alienate these valuable merchants who are the bread and butter of Etsy's business. But it's extremely encouraging to see that as of March 31, the number of active sellers was up 3.8% year over year to 7.9 million. This is a clear indication of Etsy's value to its seller base. What's more, the company currently has 95.5 million active buyers, which also increased compared to the prior year.
Etsy has many favorable traits
To be clear, a single quarter's performance isn't enough of a sample size to make a smart move with the stock. But by zooming out, investors can better understand Etsy's favorable traits. I think there are three factors that really stand out with this e-commerce business.
For starters, Etsy truly provides a differentiated offering. Whereas Amazon is known for providing the widest selection of merchandise at low prices and as quickly as possible, Etsy takes a different approach, focusing instead on unique and handcrafted products. According to a company survey, 87% of buyers said that Etsy has items they can't find anywhere else. That demonstrates a meaningful value proposition.
Another attractive characteristic of this company is that it benefits from network effects. The more sellers that choose to run their businesses on Etsy's platform, the more compelled buyers will be to shop on the site because there will be greater choices. The opposite is also true. As Etsy grows its buyer base, sellers will naturally be inclined to go where the customers are.
Adding to its powerful network effects, because Etsy doesn't own any inventory itself, it's a capital-light enterprise. In other words, the company simply offers just a platform that connects various buyers and sellers. This usually results in incredible profitability as the business scales up. Between 2016 and 2021, Etsy's gross margin went from 66.2% to 71.9%, and its operating margin rose from 5.1% to 21.6%. (Note: I excluded 2022 because of a one-time impairment charge that led to negative earnings.)
For Etsy, any additional transaction that occurs on its marketplaces should produce very high margins. This is because the underlying infrastructure is already built out. But management continues to invest in improving the service, with the most recent move being the planned use of artificial intelligence to bolster the user experience.
Investors should consider the valuation
Over the past five years, Etsy's stock has climbed 217% -- a very impressive return despite shares being 69% off their peak. With the stock under so much pressure lately, investors can own shares at a forward price-to-earnings ratio of 21. This is cheaper than the forward multiple of 26 for the Nasdaq-100 index.
Add this to Etsy's healthy financial results and its wonderful operational qualities, and it's not hard for investors to get bullish on the stock right now.
