While this year has been rewarding for shareholders in general, investors in Etsy (ETSY 0.34%) have been disappointed. Shares of the online marketplace have fallen 37% through November, and they currently sit 75% below their peak price from 2021.
The first thought might be to completely avoid this business. But I think this would be a mistake. Etsy has some favorable characteristics that can't be ignored.
Here are three reasons investors should strongly consider buying this top e-commerce stock right now.
Economic moat
The mark of a truly outstanding business is the presence of an economic moat. Warren Buffett would agree with this statement.
Etsy benefits from powerful network effects. The two-sided marketplace gets stronger as it gets larger. With more sellers offering a wider range of merchandise, buyers have a lot more shopping choices. And as there are larger numbers of buyers coming on board, sellers have a growing customer base to target.
Network effects solidify Etsy's competitive position in the broader e-commerce space by discouraging newcomers from entering the industry. If an ambitious entrepreneur wanted to start a rival marketplace, they'd have to simultaneously attract buyers and sellers onto the platform, which seems like an almost impossible task.
Plus, Etsy offers a truly differentiated service. While Amazon has found tremendous success by focusing on speed, convenience, price, and a massive selection, Etsy is all about unique, handcrafted, vintage, and specialized goods, carving out a niche in the competitive industry.
Growth has slowed thanks to macro-related headwinds, but by zooming out, we'll quickly see how much progress Etsy has made over the year. In fact, the user base of buyers and sellers, gross merchandise sales, and revenue are all significantly higher than they were prior to the pandemic in 2019.
And management thinks the company has barely scratched the surface of its total addressable market opportunity. This adds meaningful upside as we look to the future.
Strong financials
Thanks to a one-time $1 billion goodwill impairment charge, Etsy's financials took a huge hit in 2022. Management basically admitted they overpaid for two acquisitions, Elo7 and Depop, that were made in 2021.
But don't let that distract you from Etsy's impressive numbers. The company's operating margin went from 0.6% in 2015 to nearly 22% in 2021. Although this figure has come down over the past several quarters, it's because Etsy continues investing in product development and marketing initiatives, both of which should position the business well once revenue growth reaccelerates.
Investors will also appreciate that Etsy generated $669 million of free cash flow in the trailing 12-month period. Add this spectacular profitability to a reasonable long-term debt burden of $2.3 billion, and it's easy to see that Etsy can weather whatever economic turmoil is thrown its way, just like it already has.
Attractive valuation
As I noted earlier, Etsy's stock is 75% lower than its all-time high. And a clear indication of investor pessimism is the fact that shares have gone in the opposite direction of the broad market indices in 2023 thus far.
But at this point, the setup for bullish investors couldn't be any better.
Etsy currently trades at a forward price-to-earnings ratio of 16. For comparison's sake, the S&P 500 and Nasdaq 100 trade at multiples of 20 and 28, respectively.
Etsy's current valuation is incredibly attractive, especially given the favorable attributes I discussed earlier. The best course of action is to consider adding this business to your portfolio.
