For many investors, an ideal outcome is to find a business that can turn relatively modest investments into a $1 million position one day. By focusing on high-quality businesses trading at compelling valuations, getting to that seven-figure number is a possibility over the long term.
But could Etsy (ETSY 3.32%) be the kind of stock that could get you there? The e-commerce company's shares currently trade 79% below their all-time high, so while it has been disappointing its long-term shareholders, it could have plenty of room for a rebound.
Etsy's business is struggling
The first-quarter report Etsy delivered on May 1 clearly upset Wall Street, based on the stock's immediate 15% drop in its wake. The numbers point to continued struggles for the business.
Gross merchandise sales -- the total dollar amount of activity happening on the platform -- totaled just under $3 billion in Q1. That was down 3.7% year over year and down 5% compared to the first quarter of 2021. After posting strong growth during the depths of the pandemic, spending on the platform has slowed dramatically.
"So far, 2024 is still proving to be a cyclically challenging period for us," CEO Josh Silverman said on the earnings call. Etsy faced the same problem in 2023 -- softer discretionary spending behavior among consumers.
Etsy has attractive qualities
It's hard to ignore the ongoing challenges Etsy is facing. But the company does have some positive attributes.
For starters, its user base keeps expanding. It had 96.4 million active buyers and 9.1 million active sellers in Q1 -- and both of those metrics were up compared to the year-ago period. People are clearly intrigued enough to want to come to Etsy in the first place. The hope is that its growing cohort of users eventually leads to higher gross merchandise sales.
Etsy also possesses an economic moat in the form of a powerful network effect. Because it operates a two-sided platform that brings sellers together with customers, adding new buyers creates immediate value for those sellers, and encourages more of them to list their wares on the platform. And as more sellers set up shop on Etsy, buyers have greater choice, and more reason to patronize the site.
Despite weaker demand trends, Etsy remains consistently profitable. It generated $63 million of net income and $59 million of free cash flow in the first quarter. And its operating margin -- now 10.5% -- has significantly expanded over the longer term, although it has been somewhat volatile and on the decline since 2021.
Given the company's issues, investors might view its margin performance skeptically. However, the executive team still thinks Etsy has massive opportunities ahead of it to grow gross merchandise sales and revenue, particularly in its core markets of the U.S., Canada, U.K., Germany, France, Australia, and India.
The valuation is compelling
For investors who can look past the near-term problems, this might be an ideal moment to scoop up shares. Etsy stock trades at a dirt-cheap forward price-to-earnings ratio of 13.5, compared to the 20.7 multiple of the S&P 500.
In my opinion, this beaten-down valuation indicates the heightened pessimism that investors have about this company. Consequently, it creates a scenario where there is sizable upside potential over the long term. Of course, to deliver on that upside potential, Etsy will need to start reporting improving fundamentals.
Yes, Etsy is dealing with some challenges. But I believe the risk-reward setup here offers an attractive chance to achieve market-beating long-term returns. Investors who can put more money to work and who have extended time horizons have the best shots at becoming millionaires from this stock.
