Like many other e-commerce companies, Etsy (ETSY 0.34%) has had a tumultuous past few years. It all started with increased business in the early days of the pandemic, as people stuck at home had little choice but to shop more online. But this trend didn't last, and Etsy suffered as things reverted to normal.
The company's shares are down by 48% since the year started, partly a result of somewhat challenging economic conditions. Still, Etsy isn't dead in the water; far from it. Let's consider why it's worth buying shares of this company on the dip.
The strengths and weaknesses of Etsy's niche
Etsy is best known for focusing much of its efforts on one narrow niche of the e-commerce sector. It offers products that are hard to find elsewhere, including unique handmade goods, rare and vintage items, etc. On the one hand, that somewhat limits Etsy's potential. Wouldn't it be better to cast a wide net and have a library of goods as comprehensive as possible? Etsy doesn't think so.
There is one significant advantage to Etsy's business model. Its area of specialization allowed it to build a brand name in its niche and become a leader in this space, which grants it some degree of pricing power.
Merchants offering vintage goods know Etsy is one of the best places to sell them, so they will be willing to pay extra to use the platform, all to get their products in front of their potential customers.
Etsy has also developed a network effect, where buyers and sellers of the products it offers increasingly flock to the platform to find each other, making it more valuable. That's all well and good, but there is a key weakness to the company's strategy. Vintage and rare items generally aren't cheap, nor are they considered necessary goods. If a recession hits, they are precisely the kinds of things people will buy less of.
That's one reason Etsy's financial results haven't been as impressive lately. In the third quarter, Etsy's gross merchandise volume increased by just 1.2% year over year to roughly $3 billion. The company's revenue of $636.3 million grew by 7% year over year. Etsy used to increase its top line at much stronger rates. On a positive note, the company turned a net loss of $963.1 million in the third quarter of 2022 into a net income of $87.9 million.
Etsy also showed progress on other fronts, including its gross profit and earnings before interest, taxes, depreciation, and amortization (EBITDA) margin. While the company is still feeling the effects of economic challenges, things aren't looking too bad.
Why there is still plenty of hope for Etsy
Beyond the fact that economic conditions will change eventually and help improve Etsy's business, there are other things that investors should monitor.
First, Etsy continuously attempts to enhance the shopping experience by implementing new features on its platform. Second, there is the company's deepening network effect, and finally, its total addressable market.
Starting with the first item, Etsy has long made it a point to make changes to its website to drive better search results and increase visibility and conversion for merchants. The company is still doing that.
In its third-quarter letter to shareholders, Etsy said it has been testing a new artificial intelligence (AI) tool designed to improve the search function on its website to deliver better, more accurate, and more relevant search results.
The feature is showing promise, but various AI applications, including machine learning, have been important to Etsy's business for a while. As the company's CEO, Joshua Silverman, said during its first-quarter earnings conference call, "Longer-term efforts to improve product search using machine learning have started to really pay off. We're exposing buyers to more relevant and personalized content to browse and explore, and we're making the seller listing process better to improve the quality and quantity of listings."
Etsy's latest initiative is a continuation of these long-term efforts, and the company should continue down that path.
Second, Etsy's buyers and sellers increased during the third quarter. Active buyers came in at 97.3 million, a 3.4% year-over-year increase, while active sellers of 8.8 million jumped 19% compared to the year-ago period. Increases in these metrics are important as they show that Etsy can grow its user base even amid challenging macroeconomic conditions. This is a good sign that, over the long run, the company's engagement and economic moat could deepen.
Lastly, Etsy still has plenty of room in its addressable market. For one, the e-commerce industry is unlikely to have peaked. Analysts continue to project that it will grow rapidly in the coming years. Further, Etsy estimates that it has barely scratched the surface of its massive $2 trillion niche. So, despite issues this year, investors can remain optimistic about Etsy's future and buy shares of the company while they are down.
