With people stuck at home and brick-and-mortar shopping an unpopular (or impossible) option, Etsy (ETSY 2.86%) benefited greatly from the coronavirus pandemic. Active buyers, active sellers, and gross merchandise volume (GMV) soared. But the economic reopening, and the current inflationary period we've been experiencing, have hurt the business noticeably.
As we try to step back and focus on the longer term, where will Etsy stock be in three years? Let's take a closer look at the prospects for this top e-commerce marketplace.
Differentiation is key
We can't really talk about Etsy without focusing primarily on what makes the marketplace so valuable in the first place. According to a recent survey, 87% of buyers on the platform said that it had items they couldn't find anywhere else. Think about how powerful that situation is. It immediately demonstrates why the business exists in the first place, plus just how wonderful a competitive position it has.
The competition in e-commerce is undoubtedly fierce, but Etsy's focus on differentiation is critical to its lasting success. This key feature is why investors might want to remain optimistic about its future.
As of March 31, Etsy counted 7.9 million active sellers, up 3.8% year over year. That gain might seem unimpressive at first glance, but consider that the company raised the fee it charges these sellers in April 2022, from 5% to 6.5%. The fact that Etsy didn't lose a ton of sellers, and instead added some, is an obvious sign of the value it provides.
That bodes well for management's ability to exercise its pricing power in the future. This is something Warren Buffett would definitely appreciate.
Strong financial position
In 2022, Etsy posted a rare net loss of $694 million. But this was due to a one-time goodwill impairment charge of $1 billion to write down the value of its previous acquisitions of Depop and Elo7, an admission by management that it severely overpaid for these smaller online marketplaces. Typically, though, Etsy has proven that it can be a solidly profitable enterprise.
Excluding last year, between 2016 and 2021, the business was able to expand its operating margin from 4.8% to 20%. That's a clear indicator that Etsy can scale extremely well as it grows. That's generally because the tech and data infrastructure is largely developed, so every additional transaction likely carries high margins.
The management team believes that Etsy's addressable market is gigantic. It's estimated at $466 billion in the company's seven core markets (U.S., Canada, Australia, U.K., Germany, France, and India). Should the business be able to penetrate what is seemingly a huge opportunity, GMV and revenue are sure to rise. And thanks to Etsy's capital-light business model, as exemplified by its expanding margins over time, profits and free cash flow could also be on their way up.
Patience could be rewarded
At a high level, it's easy to come to the conclusion that Etsy is a solid business. Providing a valuable online marketplace where buyers and sellers can connect over truly differentiated products is clearly in demand. Moreover, this business model has been extremely lucrative.
The stock price, while up 176% over the past five years, is currently 69% off its peak from November 2021. Like many other growth tech stocks, Etsy has face the perfect storm of a post-pandemic normalization of consumer behavior and macroeconomic headwinds, with experts predicting a recession in the near term.
It can be nerve-wracking to put on your contrarian cap and decide to buy a falling stock, especially when the underlying business is also dealing with a dramatic slowdown. But for patient investors who are willing and able to wait for their investments to work out, Etsy might be positioned well to provide solid returns over the next three years.
