Etsy's (ETSY 3.18%) latest financial report (for the second quarter of 2023, ended June 30) was better than expected. Revenue totaled $629 million, with diluted earnings per share of $0.45. 

However, this didn't prevent the stock, which is down 16% from the date of that earnings announcement, from sliding. Zooming out, shares are down 33% in 2023 (as of Aug. 8), a stark contrast from the 32% gain of the Nasdaq Composite index. 

Let's take a closer look at one green flag with this e-commerce company's latest earnings report, as well as one red flag that investors should be aware of. 

Green flag: Growing user base 

Etsy grew its user base last quarter on a year-over-year basis, adding sellers and buyers to the platform. As of June 30, the business counted 8.3 million active sellers and 96.3 million active buyers, both figures up from three months earlier. A growing user base is a clear sign the company is expanding, even in an uncertain economic environment.  

"The Etsy marketplace's active buyers reached an all-time high in the second quarter, signaling the relevance of our brand and our ability to create opportunities for our sellers," CEO Josh Silverman said. An active buyer or active seller is someone who made a single purchase or sale, respectively, in the past 12 months. 

Attracting more users is the key to achieving long-term growth for platform business models like Etsy. Then, it's important to find ways to increase engagement and better monetize this activity over time. While Etsy's marketplace might lean toward discretionary, one-off purchase items, the fact that it has increased its buyers and sellers could be a harbinger of more spending in the future. And this would lead to greater revenue. 

This is what shareholders want to see. In 2022, Etsy's active buyers and active sellers declined from the year before, sparking fears that perhaps the marketplace's expansion was coming to an end. But this was likely caused by the normalization of consumer behavior following a huge surge in demand during the pandemic. Last year's results were also spurred by the Fed hiking interest rates and worrying everyone that a recession was imminent. 

Red flag: Declining gross merchandise sales 

Gross merchandise sales (GMS), which measure the amount of dollar transaction volume that occurs on the platform in any given period, were down 0.6% year over year compared to Q2 2022. For the first six months of 2023, the drop was more pronounced, at 2.7% versus the same period last year. This continues a trend that started in 2022. GMS totaled $13.3 billion, but it was lower than the $13.5 billion registered in 2021. 

For Etsy, growing GMS is critical because the business receives fees directly from the transactions that happen. If GMS keeps shrinking going forward, it doesn't bode well for Etsy's prospects. And while it might be encouraging that the company's revenue in Q2 jumped 7.5%, this was largely attributable to higher fees charged to sellers. Constantly raising fees to offset weak GMS trends isn't a sustainable strategy because it can cause sellers to leave for competing platforms to avoid having to pay so much to run their small businesses. 

For what it's worth, the leadership team mentioned something that's encouraging for shareholders. "While year-over-year consolidated GMS growth were made negative in April, trends turned positive in May and June," said CFO Rachel Glaser. And for the third quarter, management expects GMS to show a slight increase on a year-over-year basis. 

Investors should pay close attention to GMS trends in the next few quarters because this has a direct impact on revenue, which obviously can trickle down the income statement to profitability. And this can influence what happens with the stock price.