Recession fears drove the S&P 500 into a bear market last year, and the benchmark index is still down 11% from previous highs. But investors can confidently assume the decline is temporary. The S&P 500 has never failed to rebound from past drawdowns, and a bull rally will eventually put an end to the current bear market. That makes the current situation a buying opportunity.
While waiting for the bull market to get underway, investors should take a close look at Etsy (ETSY -0.46%). The stock is currently trading 71% off its high, but the niche e-commerce company is well positioned to grow as more shopping takes place online, and its share price could soar when the economy regains its momentum.
Here's why this unique growth stock is worth buying today.
Etsy had mixed financial results in the first quarter
The pandemic put Etsy on the map for many people, but the company lost much of its momentum over the past year as digital tailwinds gave way to economic headwinds. High inflation curbed discretionary consumer spending, and unfavorable foreign exchange rates dragged on the top and bottom lines. Those financial pressures led to mixed results in the first quarter.
Gross merchandise sales (GMS) slipped 5% year over year during the quarter, due primarily to a decline in spending per active buyer. Yet, revenue increased 11% to $641 million as Etsy flexed its pricing power. The company managed to increase its take rate (revenue as a percentage of GMS) by raising transaction fees and generating more ad revenue. But GAAP earnings still dropped 12% year over year to $0.53 per diluted share.
Looking ahead, management expects economic headwinds to persist in the second quarter. Guidance implies a slight year-over-year decline in GMS and single-digit revenue growth. But investors should focus on the big picture. Etsy may struggle in the near term, but the company should be able to reaccelerate growth when economic conditions improve and consumer spending rebounds. Etsy has a strong competitive position and a large addressable market.
Etsy has a strong competitive position
Etsy operates four online marketplaces as part of its "house of brands" strategy. Three of those web properties -- Reverb for musical instruments, Depop for fashion resale, and Elo7 for Brazilian handmade goods -- are relatively small. They accounted for just 12% of GMS in 2022. But its namesake Etsy marketplace accounted for the other 88% of GMS, and it currently ranks as the sixth most visited online shopping destination worldwide.
What's driving that success? The Etsy marketplace is somewhat unique. It specializes in handcrafted, vintage, and artisanal goods, connecting people with non-commoditized products that would be difficult to find at other retailers. Etsy also encourages communication between buyers and sellers so that many items on the platform can actually be customized or personalized. Few retailers (if any) offer a similar shopping experience.
Management has an ambitious product roadmap
Return on invested capital (ROIC) measures how effectively a company spends money. Etsy achieved a median ROIC of 16.9% over the last three years, while Amazon and Walmart achieved median ROICs of 16.7% and 9.7%, respectively. That means Etsy is investing capital more efficiently than the two largest retailers in the world, so investors have good reason to be confident in the product roadmap that management has outlined.
One priority is improving search and discovery on the marketplace. Buyers often struggle to find the right product because non-commoditized inventory is difficult to organize. So Etsy has been tweaking its artificial intelligence (AI) models to make search results and ad campaigns more relevant, and the company continued to make progress in the first quarter. For instance, by incorporating more purchase data into its AI model, Etsy was able to increase the average order value.
Building on that, recent breakthroughs in generative AI promise to further improve the search experience for shoppers. For example, rather than searching for red cocktail dresses, customers could ask the AI to recommend red dresses for a night out at cocktail bars in New York. Alternatively, people could show the AI a photo of a red dress and ask for something in a similar style, or an identical dress in a different color.
A second focus area is providing robust support for sellers and building trust with buyers. The company launched Etsy Purchase Protection last year, a program that guarantees buyers a refund for damaged or lost packages while ensuring that sellers keep their earnings. The company is now working to improve awareness of its purchase protection program. Etsy also expanded its star seller program this year to steer buyers toward Etsy shops that provide excellent customer service.
Etsy stock is trading at a discounted price
Etsy should benefit as more commerce takes place online in the years ahead. The company values its addressable market at $466 billion, but that figure rises to $2 trillion if relevant products currently sold offline are included. That leaves Etsy with a long runway for growth. Yet, shares currently trade at 4.4 times sales, a bargain compared to the five-year average of 10.6 times sales. In fact, shares are essentially trading at their cheapest valuation in the last five years. That's why this growth stock is worth buying today.
