The market has sharply bounced back this year. After dropping more than 19% in 2022, the S&P 500 rose by about 23% this year.
But the equity market doesn't rise in a straight line. There will come a time when equity prices drop precipitously for a variety of reasons. When they do, it's good to have a top stock to buy. Etsy (ETSY 0.34%) heads my list.
What makes me like Etsy during an overall market downturn? It's time to uncover the company's strengths.
Image source: Getty Images.
Growing customers
Etsy, which operates an online marketplace connecting creative goods makers with buyers, exploded in popularity during the early days of the pandemic. With people stuck at home, they came to Etsy's website in droves.
They weren't just browsers, but actually bought goods. Revenue more than doubled in 2020 to $1.7 billion.
While 2020 was an unusual period, it does demonstrate the site's appeal during challenging times. And Etsy has grown the number of users on its sites. On the Etsy website, the number of active buyers grew by 4% in the third quarter, to 92 million.
Although gross merchandise sales were flat after taking into account foreign currency translations, management attributed that mostly to consumers facing challenges from higher prices. As inflation recedes, I expect that to improve.
Cash flow
For the first nine months of the year, Etsy grew revenue by 8.4%. The company recorded a $224.3 million profit versus an $803.8 million loss under U.S. generally accepted accounting principles (GAAP), although it's difficult to compare given last year's $1 billion asset impairment charge.
But a company's cash flow reveals telling details about a company. That's because this is the actual money flowing into and out of the company. On this basis, Etsy generated operating cash flow of $410.4 million this year, up 4.7% from a year ago. Free cash flow (FCF), which subtracts property and equipment spending from operating cash flow, was $402.7 million.
Etsy is able to produce strong FCF since the company doesn't have to invest heavily in things like inventory or storage facilities.
This impressive feat comes as management continues to spend on expanding the business. This includes marketing and product development that should help propel growth.
Creating a better valuation
Etsy's shareholders have had a rough go over the last year. During that time, the stock price has dropped by 36% while the S&P 500 has gained more than 21%.
That's likely due to high growth expectations that were set by 2020 and a challenged consumer that hurt spending. But Etsy's site remains an increasingly popular destination. The company's price-to-sales ratio has been cut by roughly half to 4 times. Should the overall market drop, that's likely to result in an even better valuation.
For long-term investors, a falling stock market represents a good opportunity to buy strong companies at a better price. While Etsy's customers may face challenges if there's an economic downturn, they'll undoubtedly still visit and purchase items from the site, albeit lower-priced ones.
With Etsy's brand recognition, proven ability to attract site traffic, and cash flow generation, investors should seriously consider purchasing the stock when the overall market declines.
