The COVID-19 pandemic shut the world down, and lockdowns and movement restrictions boosted demand for stay-at-home activities. Online craft marketplace Etsy(NASDAQ: ETSY) was a natural beneficiary of this trend. Its stock price soared, with investors seeming to believe that the boom times would never end.
Now, the company's price tag has dropped substantially -- potentially putting it on the radars of value-hungry investors. Let's dig deeper to see if this beaten-down stock can recover over the next half-decade.
A falling star?
Etsy is a relatively established e-commerce marketplace. It was founded in 2005 and went public 10 years later. The company differentiates itself through a focus on handmade, vintage, and craft items, and it was a natural beneficiary of the COVID-19 pandemic as people turned to online shopping and self-employment while stuck at home during the crisis.
However, Etsy wasn't able to hold on to its momentum. After the pandemic boom, it saw its growth stall and shares plummet because of macroeconomic changes. Inflation made people less likely to spring for non-essential products, and to spend less when they did.
Etsy could also face rising competition from Chinese online marketplaces like Shien and Temu (a subsidiary of Pinduoduo Holdings) in the apparel industry. These platforms can produce and retail new clothing so cheaply that it becomes a viable alternative to second-hand items. E-commerce giant Amazon has also encroached on Etsy's niche with its Amazon handmade store, which focuses on craft goods.
The business is stable, but margins are falling
Etsy's shares are down 84% from an all-time high of $297, reached in late 2021, so investors can be forgiven for assuming the business is falling apart. But this isn't necessarily the case. Second-quarter earnings demonstrate relatively stable operations from a top-line perspective.
Etsy's Q2 revenue grew 3% year over year to $647.8 million. To put this figure in historical context, the company reported revenue of just $528.9 million near its stock price peak in Q2 2021. That means Etsy's top line is still growing. Furthermore,gross margins in both periods remain roughly the same at 72%. The difference mainly comes from operating margins, which have fallen from 17% to 11%.
While gross margins measure the revenue left after subtracting direct selling costs, operating margins include overhead expenses like office salaries, advertising, and product development. These outflows seem to be the main thing dragging down Etsy's performance.
Image source: Getty Images.
What will the next five years look like?
Less mature, growth-focused companies often spend a lot of money on operating expenses (like advertising and product development) to try to gain market share rapidly. Etsy's management seems to be stuck in this mindset, even though the business has matured. Over the next five years, they will need to focus on cost-cutting and efficiency.
While Etsy did lay off around 11% of its staff in late 2023, these efforts might not be going far enough, considering its low growth prospects.
Cost-cutting has been a tried and true strategy for internet companies after the pandemic's height, with examples like Amazonand Meta Platforms, which laid off tens of thousands of workers between 2021 and 2024. Their operating incomes and stock prices have soared in response. Etsy's low valuation gives it enough "dry powder" for a similar rebound.
With a forward price-to-earnings (P/E) multiple of 13, Etsy trades at a significant discount to the S&P 500 estimate of 24. This is cheap considering its stable business and ability to boost margins through cost-cutting. Shares look like an excellent deal for value-focused investors and could outperform the market over the next five years and beyond.
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John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Randi Zuckerberg, a former director of market development and spokeswoman for Facebook and sister to Meta Platforms CEO Mark Zuckerberg, is a member of The Motley Fool's board of directors. Will Ebiefung has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Amazon, Etsy, and Meta Platforms. The Motley Fool has a disclosure policy.
