With the Nasdaq Composite up an impressive 31% so far in 2023, investors might assume that most companies have benefited from the market's recent rally. But they would be wrong. Take e-commerce marketplace operator Etsy (ETSY 0.34%), whose shares are down a whopping 42% this year. They're also 77% below their peak price from November 2021.
It's evident that this online shopping destination for unique and handcrafted goods has been dealing with a notable slowdown, but the beaten-down share price presents a buying opportunity for investors interested in this growth stock.
Facing a slowdown
Etsy was posting ridiculous growth during the worst of the pandemic, with revenue rising 111% in 2020 and 35% in 2021. Gross merchandise sales (GMS), a figure that measures the transaction volume on the platform, was up 107% in 2020 and 31% in 2021. Many e-commerce companies benefited from the surge in online shopping during that time, and Etsy was no different.
Things began to slow down in 2022 due to a combination of factors: Inflation was at record highs, interest rates were on their way up, and Etsy started to face difficult comparisons. Making matters worse last year was that management decided to take a $1 billion write-down of its goodwill, basically admitting that it had severely overpaid for its acquisitions of Depop and Elo7. This deceleration has continued into this year.
It's not all bad news, however, as Etsy was able to increase its revenue 7.5% in the most recent quarter. Key to this healthy growth, in the face of flat GMS, was the company's decision to increase seller fees in April 2022. Basically, Etsy now earns more money from the transactions that occur on its platform. The so-called "take rate" was 20.9% last quarter.
It's also very encouraging that Etsy's 96.3 million active buyers and 8.3 million active sellers (as of June 30) were both up year over year. This means that users are flocking to the marketplace in greater numbers, which could bode well for GMS trends as we look ahead. Perhaps this is the beginning of potential pent-up demand that we'll see flow through Etsy's financials sometime in the near future.
Platform business model
One of the most attractive characteristics about Etsy is its asset-light business model. Unlike a typical retailer, the company doesn't own any inventory, warehouses, or delivery trucks, instead simply just matching buyers and sellers on its platform. This generally means that Etsy's working capital needs are kept to a minimum.
The result is a business that possesses very favorable financials. If we exclude 2022, which had that aforementioned impairment charge, Etsy's operating margin soared between 2016 and 2021, indicative of an enterprise that scales extremely well. Each additional transaction that happens should carry very high margins.
Etsy's economic moat comes from network effects, which are derived from operating this two-sided ecosystem that consists of buyers and sellers. The more Etsy's user base grows, the more valuable the marketplace becomes for all parties involved.
Valuation and prospects
Since the stock has gotten so hammered, investors aren't being asked to pay a steep valuation. The shares currently trade at 36 times trailing-12-month earnings. That's about half the average multiple they've sold for in the past 10 years. On a forward basis, Etsy trades at a price-to-earnings ratio of 15, which looks like a steal.
That valuation is almost a no-brainer given the company's growth potential. Just anecdotally, Etsy not only can grow on the back of the rising popularity of online shopping, but it is also in a wonderful position to benefit from heightened consumer interest in supporting small businesses on the buyer side, as well as a greater focus on entrepreneurship and starting side hustles on the seller side.
If the business can even get remotely close to the annual revenue gains it was clocking prior to the pandemic (in the 30% range), then investors are in for huge upside.
