Editor's note: This article was published on April 29 and ETSY stock was purchased for the portfolio on May 1. Etsy’s first-quarter report resulted in an 18% decrease in stock price on May 20. The author retains a positive long-term prognosis for the company and the stock, but highly recommends that potential investors read the below article for more on the strengths of the company’s business as well as some of its risks.
Through the Prosocial Portfolio, the real-money portfolio I manage for The Motley Fool, I seek out companies with positive attributes, whether it's stellar employee treatment, focus on environmental sustainability and social issues, or truly and deeply caring about customers. With any luck, they do all those things and more. I've found that looking for these factors has been a successful way to find some great stocks -- and generate some impressive returns.
Interest in all forms of socially responsible investing is increasing, yet it's still rare to find a company that could even come close to being a "pure play." Enter Etsy (NASDAQ:ETSY) -- it's forging a new path, going above and beyond when it comes to social responsibility.
To be honest, I balked at the idea of investing in Etsy as its stock began trading earlier this month, even though I was excited about the company and its mission. I usually avoid "hot" IPOs, and wait for the smoke to clear and the dust to settle. I also tend to be extremely leery of companies that aren't profitable yet.
Sometimes it's good to question our own default rules and maybe even break them once in a while. The spirit Etsy represents is perfect for the Prosocial Portfolio, so I've decided to put some real money into the stock.
Etsy and the creative edge
Brooklyn, N.Y.-based Etsy is a network of makers, craftspeople, and artists selling their wares online; Etsy is like a virtual megamall of small, diverse, unique shops and products. Its IPO prospectus trumpets how it's "Reimagining Commerce" and "Connecting People." Etsy's all about fostering creativity and entrepreneurship -- and the Internet's continued evolution, opening up economic opportunities for everyone, big and small.
Etsy sellers gain a platform to reach far more potential customers than the bricks-and-mortar world provides. Etsy's community is comprised of 54 million members, including 1.4 million active sellers and 19.8 million active buyers worldwide.
In a retail landscape that has long been dominated by chain retailers, Etsy offers consumers the choice to support small artisans and micro-businesses, giving them an alternative to mass-produced, homogenous goods and offering a selection they can access from the convenience of their computers and mobile devices.
Etsy plays into the growing freelance economy. It cites a July study that said 53 million Americans work as freelancers, and in some developing countries, more than half of the women are self-employed. Etsy's platform makes it easier for people who are going it on their own to make up for their lack of marketing, technological, and logistical resources.
To Etsy, small is beautiful, and it offers entrepreneurs a great launching pad to turn their passionate pursuits into financial opportunities.
Let's get back to being "all in" when it comes to social responsibility: Etsy is a B Corporation. That designation is reserved for companies that make a conscious effort to positively impact the world. While these companies are for-profit, they have also literally committed to run their businesses to do the right thing by stakeholders like employees, suppliers, communities, and the environment.
The private entity B Labs certifies a company as a B Corporation if it meets all its criteria. However, in a growing number of states, companies that plan to function with an eye on multiple "bottom lines" can also apply to be legal entities known as benefit corporations.
Although there are growing numbers of B Corporations -- Seventh Generation, Patagonia, and King Arthur Flour are among the most well-known -- many are small and privately held. Etsy is breaking ground for being the first American B Corporation to go public. (If IPO speculation comes to pass, Warby Parker could turn out to be the second.) Check out Etsy's page over at B Labs, which discloses some of its mission-based attributes.
Etsy's IPO included a bit of "weirdness" -- good weird. It reserved 15% of its IPO shares for individual investors, such as its own vendors, as well as other small investors, who could buy from $100-$2,500 worth of shares. Embracing individuals, particularly its own seller stakeholders, is a great way to foster a sense of sharing, partnership, and ownership, and emphasize its ardor for the little guy -- let's just straight up clarify that as a gender-neutral term, since 86% of Etsy sellers are women.
Furthermore, when it came to shopping around its IPO with larger investors, Etsy targeted those it believed would focus on the long-term mentality instead of focus on short-term financial gains.
That's important since it speaks to one of the biggest threats in trying to run stakeholder-friendly businesses these days: short-term-minded investors who demand immediate, quarter-by-quarter financial gratification. Massive business mistakes are made when companies push for immediate growth and profits to please short-term investors -- the wrong-headed approach to building "shareholder value" -- instead of building responsible businesses that will excel, and of course, profit, over the long haul.
Today's risks, tomorrow's opportunities
One of the most important notes -- and risks -- concerning an investment in Etsy is that it isn't profitable yet, and in fact, last year its loss widened. In the year ended Dec. 31, 2014, it reported a loss of $15.2 million, or $0.38 per share, a far cry from the previous year's loss of $796,000, or $0.02 per share, according to S&P Capital IQ data.
Etsy's revenue growth has been growing at a double-digit clip -- a good sign, of course. Etsy generates revenue through a mix of channels. Etsy receives a fee from each seller's transaction, and also charges a listing fee. It offers seller services, through which sellers can pay fees for promoted listings, payment processing through Direct Checkout, and shipping labels.
Last year, Etsy's net sales increased 56% to $196 million. However, note that that's a bit of a slowdown from the 68% year-over-year sales growth Etsy logged in 2013.
I believe the trends are in Etsy's favor to deliver future growth. Many consumers are disappointed with retail chains' lack of individualism and craftsmanship, and they seek deeper and more emotional connections with others -- the kind of connection you can establish with an Etsy seller who's using their creativity and skills to make unique items. In its filing, Etsy cites a 2014 study from Havas Worldwide that claims 53% of consumers would rather buy from an individual producer.
Many consumers are shifting their mind-sets, striving to support businesses that care about more than the bottom line, and companies like Etsy are perfect recipients for that kind of conscience-driven spending. Etsy sellers are keying into that desire; they generated gross merchandise sales of $1.93 billion in 2014, a 43% year-over-year increase.
Remember the risks
One of Etsy's aspects that could generate the most rewards can also be considered a risk. There's been a ton of media commentary about whether Etsy can operate according to its stakeholder-friendly principles and still generate decent returns for investors.
This potential conflict goes hand in hand with another risk that some sellers have already begun to grumble about -- that Etsy will become too stereotypically "corporate" as a publicly traded company and lose sight of its original values.
If Etsy loses its authenticity -- part of its competitive advantage -- investors had better look out. Many buyers and sellers will flee, and its brand could become tarnished. Losing its B Corporation status, which holds it to a higher standard right at the get-go, could also be disastrous. As the company grows, it could also be difficult to maintain its positive culture, which includes a higher purpose and a focus on employees.
Even beyond its lack of profitability, I'm red-flagging some spending plans. For example, it's planning to amp up its marketing spending. Oftentimes, companies overflowing with higher purpose and love for customers, employees, and other stakeholders don't have to spend much on marketing; word of mouth usually does the trick until they become far more mature.
Last but not least, Etsy's risk factors include one disclosure that could prove a problem later on. From the SEC filing: "We currently have identified two material weaknesses in our internal control over financial reporting that, if not corrected, could result in material misstatements of our financial statements."
Etsy also relayed the steps it's taking to remediate this situation, which will include some costs. The steps it outlines include hiring additional financial personnel and upgrading its systems.
I hope Etsy's work on this issue will rectify the situation so that it doesn't come back to haunt those of us who own shares. However, it is a risk that's worth filing away.
I've purchased quite a few stable and well-established companies for the Prosocial Portfolio here lately. To be frank, I consider Etsy the riskiest stock I've decided to add to the portfolio for some time.
However, with that risk comes the potential for big rewards, as well as a different kind of reward: a belief in Etsy's stakeholder-friendly mission, including its emphasis on helping indie creatives and entrepreneurs profit from their passions. While I'm hoping the financial future will be bright for Etsy as it keys into major trends, I also feel good about the positive impact it aims to have in the world.