With daily COVID-19 vaccinations sweeping broadly higher, many investors are betting dark days lay ahead for stay-at-home stocks like Etsy, Inc. (Nasdaq: ETSY).
But that line of thinking is a mistake … Esty shares are still very attractive.
On Thursday, the Brooklyn, N.Y.-based company reported blowout fourth-quarter financial results as its three-for-one business model finally rounds into form.
This business should have legs. With 62 million unique items, the business has become a legitimate digital destination for people who want to buy, sell and search for one-of-a-kind items. Etsy is one part merchant services partner, like PayPal Holdings, Inc. (Nasdaq: PYPL), another part marketplace, like Shopify Inc. (NYSE: SHOP) and another part search engine like Alphabet, Inc. (Nasdaq: GOOGL).
It’s easy to dismiss Etsy as the latest online fad … but clearly it’s not.
Products fall under a range of categories like jewelry, clothing, home décor and furniture, toys, art, crafts and tools. More often than not, the items are handmade or personalized, allowing sellers to form special relationships with their customers.
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CEO Josh Silverman said Thursday that the company attracted 61 million new buyers in Q4. All-in, customer counts grew 160% year-over-year. Revenues payable to Etsy surged to $617.4 million, up 129%. That figure was $100 million above the consensus expectation, according to FactSet. And Silverman noted that Q1 sales should clock in around the $520 million range, not exactly a huge falloff from the holiday shopping season.
However, the real kicker is Etsy’s gaudy gross margins. The online marketplace boasts 75.6% gross margins, up 920 basis points from a year ago. And even with sales and marketing expenses added back in, net profits were $148.5 million, up 375% year-over-year.
The big bump in gross margins can be attributed to online ads. Silverman and his managers are growing a real business by monetizing the search for unique items, yet that is only half of the story.
Search is far more important than ad revenue at Etsy. It’s the essence of the value proposition for buyers. They want to be able to type in a search query and have Etsy’s algorithms find exactly what they’re looking for in a sea of unique items. Getting this right is the key to growing the business. It’s why Etsy deserves its current valuation.
In a podcast interview  with the Wharton School of Business in 2019, CFO Rachel Glaser explained the company has been keenly focused on personalized search that takes into account previous items viewed, geography and everything Etsy knows about the buyer.
Silverman says Etsy is making real progress closing the semantic gap to improve search. Algorithms are yielding fewer null result searches. These improvements are moving to the mobile application too.
Meanwhile, the Marketplace and Services parts of the business have grown significantly as more sellers join the platform and use Etsy’s vendor services.
Q4 gross merchandise sales, the value of all of the products sold on Etsy, reached $3.6 billion, up 118% year-over-year. During 2020, GMS soared to $10.3 billion, up 107%.
In a filing with the Securities and Exchange Commission, Etsy managers noted that GMS for Q1 is expected to be in the $2.9 billion to $3.1 billion range.
What’s happening is important. Etsy is digitally transforming millions of real world art fairs, craft shows and festivals. While patrons will return to these events as the global pandemic subsides, investors are likely missing the bigger picture. It’s the hunt for unique treasures that drives engagement for a large number of buyers.
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By relentlessly focusing on search, Etsy managers are making hunting easier.
On Etsy, search is possible for more than 60 million items that have no product stock keeping unit identifiers. Getting search right without SKUs is a big competitive advantage. It should also change the way buyers shop, even when the pandemic ends.
Shares trade at 73 times forward earnings and 17.4 times sales. These metrics are a hefty premium to eBay Inc. (Nasdaq; EBAY), an online marketplace competitor trading at 14 times forward earnings and 4 times sales, respectively. In my opinion, the valuation gap is warranted given Etsy’s disruptive position.
Savvy investors should look to buy shares using any near-team weakness.
Best wishes,
Jon D. Markman
