Though the S&P 500 has rallied from last year's bear market low, some growth stocks still haven't recovered from the tough market times. Amid ongoing economic uncertainty, investors have hesitated to go all in on certain players that depend on the consumer.
Two examples are e-commerce companies Chewy (CHWY 2.99%) and Etsy (ETSY 0.34%). They've each dropped more than 30% since the start of the year.
But Wall Street is optimistic about these beaten-down stocks and expects them to climb more than 50% over the coming 12 months. Both Chewy and Etsy have offered us some bright signs about the future.
Could Wall Street be right? Let's take a closer look at each stock and find out.
1. Chewy
Chewy is an online seller of pet supplies -- and a lot more. At Chewy, you'll find just about everything for your pet, even prescription medicine and insurance. And that has won over plenty of pet owners, who are spending more and more at the e-commerce site.
Even though Chewy didn't grow its active customer base in the most recent quarter, the loyalty of current customers is reason to be optimistic. In the earnings report, Chewy said net sales per active customer rose more than 14%.
Many Chewy regulars sign up for a service called Autoship, which allows them to automatically receive their favorite products. And this offers us another positive sign: Chewy continues to see growth in Autoship. This is key because the service makes up more than 75% of total sales.
Despite today's tough economy, Chewy still reported a double-digit increase in overall net sales in the quarter and made gains in free cash flow.
CHWY Free Cash Flow data by YCharts.
And the company reported its first annual profit last year.
Chewy is showing confidence in its future by launching a plan to expand in Canada, a market where it could reach the same level of success in terms of market share and profitability as in the U.S. It aims to open in Canada during the third quarter.
Before considering whether Wall Street's predictions may come true, let's talk about Etsy.
2. Etsy
If you've ever looked online for a unique handmade gift for someone, you probably have stumbled across Etsy. The platform offers craftspeople the opportunity to open up a shop and shoppers the opportunity to buy their creations.
Etsy saw growth take off during the earlier days of the pandemic as people favored online shopping. And though recent times have been tougher due to the economy, Etsy's been able to keep the growth it's gained over the past few years. For instance, adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) in the second quarter represented a compound annual growth rate of 43% over the past four years.
The company has offered us some positive signs for the future, such as a recovery in Etsy Marketplace gross merchandise sales (GMS). In May, June, and July, Etsy reported increases in GMS year over year.
The company reported a gain in active buyers, with these loyal shoppers reaching a record high of 91 million. It also reactivated 21% more buyers than it did in the year-earlier period.
Like Chewy, Etsy should benefit over time from this core customer base, and it's doing everything it can to make the shopping experience better and keep buyers coming back. For example, the company is using artificial intelligence to improve shoppers' searches and help them find just the right products.
Finally, Etsy's capital-light structure means it doesn't face high investment costs -- so the company can transform almost 90% of its adjusted EBITDA into free cash flow. This plus Etsy's cash level of more than $1 billion should prepare it well for long-term success.
Is Wall Street right?
Let's consider the valuation of each of these e-commerce players. Today, Chewy shares trade for 41x forward earnings estimates, down from as much as 120 earlier this year. Etsy trades for 15x forward earnings estimates, down from more than 40x early last year.
At the same time, Chewy has become profitable and maintained growth among its core customers, and is set to expand in a potentially big market. This e-commerce player clearly has what it takes to gain over time.
Etsy has seen GMS decline in recent quarters as inflation rose and consumers watched their budgets. But the economic environment is temporary, and Etsy has shown signs of recovery and strength. This should help the stock climb over the long term.
But 50% in 12 months? Wall Street might be a bit too optimistic.
Economic troubles will likely continue, and this could weigh on investors' appetite for these stocks in the coming months. But don't let that scare you off. Instead, use this as an opportunity to get in on these potential long-term winners at a great price.
