Is Etsy’s Run Over?

Is Etsy stock (NASDAQ: ETSY) pricey, trading at about 140x earnings? Not at all. Especially if you consider the fact that the earnings could be about 4x current levels by 2023. How is that possible?

Firstly, we believe that Etsy’s revenues can grow by 2.7x to levels of about $2.2 billion in 2023 from about $820 million in 2019 and an estimated $1.2 billion in 2020, representing a growth rate of almost 38% per year (for context, annual growth was about 31% over the last three years). Etsy has executed well in carving out a niche for itself in the e-commerce space, focusing on handmade products, vintage items, and craft supplies, fending off competition from the likes of Amazon Handmade marketplace. While the company has grown its gross merchandise sales (GMS) at a CAGR of 21% since 2016 to $5 billion in 2019, it still remains small in context to its addressable market of $250 billion online for relevant categories it sells and over $1.7 trillion, including the offline space. ^[1] With Covid-19 expected to accelerate the shift online, Etsy’s growth rate should only rise. For perspective, Etsy indicated the GMS rose by 79% year-over-year in April 2020, even after excluding mask sales. ^[2] Etsy’s advertising sales are also soaring, with its Services business (about 25% of total revenue), which includes ad sales, more than doubling between 2017 and 2019.

Did you know Etsy stock is up 5x since late 2017? See our analysis How Did Etsy Stock Grow Over 5x Since 2017? for the underlying numbers behind the surge.

Combine revenue growth with the fact that Etsy’s Net Margins (net income, or profits after all expenses and taxes, calculated as a percent of revenues) are on an improving trajectory – they grew from roughly -8% in 2016 to about 12% in 2019. Etsy’s larger e-commerce platform peers such as eBay have operating margins that were roughly double Etsy’s as of 2019. Considering this, it’s reasonable to assume that Etsy’s margins could at least improve 1.5x to about 18% by 2023. Why is this possible? Etsy’s key fixed costs of Product development and Marketing and Administration are likely to fall in relation to its revenue growth, while variable costs – which primarily include credit card payment-related costs and cloud hosting costs could also be better negotiated as the company gets larger. So is 4x growth in earnings possible in the next five years? Yes. This looks very reasonable when you combine 2.7x revenue growth with the 1.5x growth that’s possible in Etsy’s margins.

Now if earnings grow 4x, the P/E multiple will shrink to 1/4th its current level, assuming the stock price stays the same. But that’s exactly what Etsy’s investors are betting will not happen! If earnings expand fourfold over the next few years, instead of the P/E shrinking from around 140x now to about 35x, a scenario where the P/E metric falls more modestly to about 100x looks more likely. For context, the broader online retail sector traded at a forward multiple of about 86x ^[3], while e-commerce bellwether Amazon trades at over 150x. One might assume that Etsy will trade closer to these levels. This would make a roughly 3x growth in Etsy’s stock price a real possibility in the coming years.

Interested in mega-cap tech stocks? Should you pick Amazon over Microsoft? Find out in our analysis Amazon vs. Microsoft: Does the price movement makes sense. Separately, which S&P 500 component stocks have the best chance of outperforming the benchmark index? Our 5 In the S&P 500 That’ll Beat The Index: TWTR, ISRG, NFLX, NOW, V look promising.

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1. Etsy Form 10-k [↩]
2. Etsy Q1 2020 Investor Presentation [↩]
3. PE Ratio by Sector, NYU Stern, January 2020 [↩]