After expanding at a torrid clip during the early stages of the pandemic, many e-commerce companies have seen growth slow as people have returned to their traditional shopping destinations. Many investors, in turn, have bailed out of their previously high-flying stocks. That's a mistake.
Etsy (ETSY -0.22%) is one company that has a particularly bright future. And with its shares now down sharply from their highs, the online retail star's stock is a compelling buy today.
Here are five reasons why.
1. Etsy provides compelling value for buyers and sellers
With its focus on handmade goods, Etsy is uniquely positioned within the e-commerce industry. Many products found on its marketplaces can't be found elsewhere. That brings buyers to its sites and keeps them there.
The company's management believes they can further differentiate their e-commerce platform via its search tools, a combination of text-based and relational search engines, which allow Etsy to display more accurate, personalized product listings based on the keywords a shopper enters and similar interactions between other buyers and sellers.
Although this technology is somewhat standard among the major e-commerce marketplaces, Etsy takes it one step further. Through its investments in generative artificial intelligence (AI) and other advanced machine learning technology, Etsy plans to offer a more conversational shopping experience, akin to speaking with a salesperson in a traditional retail store.
Along with finding ways to serve buyers better, Etsy knows that helping its sellers grow their businesses is also vital to its success. So the company spent hundreds of millions of dollars on advertising in 2022. It plans to spend even more this year to capture additional consumer mindshare and bring more potential customers to its merchants.
Etsy is also investing in its ad-targeting solutions and member support services to further strengthen its value proposition to sellers. These initiatives should help sellers build upon the nearly $12 billion in sales they generated on Etsy's platform in 2022 in the coming years.
2. Network effects should fuel Etsy's growth
By serving as a digital platform that brings buyers and sellers together, Etsy benefits from powerful network effects. Etsy's marketplaces become more valuable to merchants as more people shop on its sites. And as more sellers join its platform, they increase the selection of unique, handcrafted goods listed for sale, thereby increasing the value for buyers.
This helps to explain why the number of active buyers and sellers on Etsy's sites grew by nearly 1% and 4%, respectively, to 95.5 million and 7.9 million in the first quarter, amid a tepid overall e-commerce sales environment. These gains are even more impressive when you consider that they came after Etsy raised the transaction fee it charges sellers from 5% to 6.5% last year.
3. Etsy has long runways for expansion still ahead
A compelling value proposition for both buyers and sellers, combined with strong network effects, contributed to a 164% surge in Etsy's gross merchandise sales (GMS) since the pre-pandemic first quarter of 2019. And yet Etsy is still just scratching the surface of its vast market opportunity. Etsy's roughly $12 billion in annual GMS accounts for just a tiny fraction of an online retail market that's projected to exceed $8 trillion by 2026, up from $5.7 trillion in 2022, according to Statista.
Data source: Statista.
It's true that Etsy serves a niche portion of this massive global market. But there's clearly plenty of room for the e-commerce platform to expand into new product categories and grow its customer base in the years ahead.
4. Etsy employs a capital-light business model
Better still, Etsy won't need to incur much in the way of capital expenditures as it scales its operations. Now that its digital platform has largely been built out, adding new buyers and sellers to its network shouldn't cost much.
Etsy's capital-light business strategy enables it to produce robust free cash flow to the tune of $650 million over the trailing 12 months. This bountiful cash production has also allowed the company to rack up over $1 billion in cash and investments. Etsy's financial fortitude helps to lessen the risks for investors.
5. The stock is priced at a discount
Despite Etsy's intriguing long-term prospects, investors appear to be focusing on the somewhat tepid near-term forecast for e-commerce sales. This is understandable since growth stocks must grow their sales and profits to justify their typically lofty valuations.
But following the roughly 27% year-to-date decline in its stock price, Etsy's shares are now far from expensive. And as discussed, Etsy's long-term growth story remains intact.
Etsy's shares can currently be had for less than 17 times its trailing free cash flow. This is an attractive price for a high-quality business that's expected to grow its per-share profits by 16% annually over the next five years, even after accounting for any short-term macroeconomic headwinds.
