For many once high-flying pandemic-boosted businesses, growth has slowed dramatically in a different economic environment. Etsy (ETSY 0.34%) fits squarely in this category.
The online marketplace for unique, vintage, or handcrafted goods reported a 0.7% year-over-year decline in gross merchandise sales (GMS), with its net income cratering 24%. Based on the shares' immediate drop, investors weren't too pleased with the fourth-quarter 2023 financial update that management provided.
But the e-commerce stock, which is trading 76% below its peak price, strikes me as a smart buy for three very important reasons.
Differentiated platform
The retail sector broadly, and e-commerce more specifically, is incredibly competitive. Smaller businesses have to compete with the likes of dominant retail entities like Amazon, Walmart, and Costco. That's not an easy task.
But Etsy has a couple of aces up its sleeve. This company stands out because of its differentiated product offerings. A survey by the company revealed that 87% of Etsy buyers say the site has items they can't find anywhere else. This proves that the business adds unique value to the e-commerce industry.
Etsy's key merchandise categories range from home furnishings and apparel to jewelry and craft supplies, providing shoppers with a seemingly unlimited number of unique choices. This is exactly what protects the business from Amazon, which focuses more on speed, convenience, and low prices on millions of goods.
Understanding that Etsy can't compete with the tech juggernaut, it chooses to play a different game. And this has resulted in 2023 GMS totaling $13.2 billion, up from $5 billion in the pre-pandemic fiscal year 2019. Management estimates the company's total GMS opportunity per year to be near $466 billion.
Network effect
Businesses that possess an economic moat are better able to fend off competition and sustain long-term viability. This is a trait that Warren Buffett looks for in potential investment opportunities, as it indicates a high-quality company.
With 96.5 million active buyers and 9 million active sellers, Etsy benefits from a powerful network effect. The user base continues to expand, despite economic uncertainty, demonstrating its appeal.
As more buyers look for items on the platform, the growing potential customer base benefits sellers. And with more sellers listing more products, buyers have greater choices of where to spend. By being a global marketplace, Etsy can match buyers and sellers on opposite sides of the globe.
It's worth pointing out that Etsy doesn't own any inventory itself, and this means no warehouses or delivery drivers. This makes the company asset-light, as it generates revenue from transactions that occur on its site without actually delivering the physical (or digital) goods.
Historically, this business model has been incredibly lucrative. Between 2015 and 2023, Etsy's operating margin expanded from 0.6% to 12.7%. This is remarkable scalability.
The hope is that as economic conditions improve and consumer spending rises, Etsy can get back to boosting its profitability in the years ahead.
Compelling valuation
In the last three years, Etsy's shares have been obliterated, seriously underperforming the major market indices. Consequently, it should come as a surprise to no one that the stock is incredibly cheap right now. Etsy's current forward price-to-earnings ratio is 13.1, based on bottom-line forecasts from Standard & Poors. That's less than half its trailing-three-year average of 31.7.
It's strikingly clear to me that the market has grown extremely pessimistic about Etsy's prospects. It's understandable why. Demand was robust and spending on the platform was surging during the pandemic, and bearish investors perhaps think the days of strong growth are nothing but a fading memory.
I'm more optimistic. Etsy is well positioned as a more efficient organization now, thanks to huge layoffs. And the leaner, meaner business model has proven to be consistently profitable. This makes Etsy a smart buy today, in my opinion.
