After A 50% Plunge, Is Etsy A Stock To Buy?

  • The niche marketplace Etsy had a very successful IPO, and its stock price yielded more than a 100% return for early investors.
  • Overvaluation, alleged counterfeits, disappointing Q1 results, and growth concerns turned Etsy into a falling knife.
  • The strong negative sentiment against Etsy should start to fade away, and, at $10-$12, the stock should become attractive again.
Is Etsy a buy

Etsy (NASDAQ:ETSY), the arts and crafts marketplace, went public in April in a very successful market debut, with a 112% increase from its $16 IPO price. As most of the increase happened before the opening, Etsy’s early investors were able to get very impressive returns on their investment; however, investors who bought the stock on the open market experienced severe losses when the stock dropped by more than 50%, to $14.3.

In an earlier pre-IPO article on Etsy, I mentioned that Etsy has to offer investors a price that reflects a P/S ratio that is between Alibaba’s (NYSE:BABA) ratio of 19 and eBay’s (NASDAQ:EBAY) ratio of 4 in order to remain attractive. Initially, Etsy priced its IPO shares at $16, the high end of the IPO price range, which reflected a market cap of $1.5B for the company at a P/S ratio of 9. This attractive price-to-sales ratio together with Etsy’s impressive growth and future potential made Etsy’s IPO shares very appealing to investors, a fact that quickly pushed their price up to $31 before reaching a high of $33. At the end of the first day of trading, Etsy’s price reflected a market cap of almost $4B and a P/S ratio of 19 for the niche e-commerce company. For comparison, at the same time, eBay had a P/S ratio of 4 and Amazon had a P/S ratio of 2.

With such a steep valuation, a sharp correction was inevitable, and Etsy dropped more than 50% in the following two months, as presented in Chart 1 below.

Etsy_chart 7_062415

To be fair, overvaluation concerns are not the only driver for Etsy’s free fall. Shortly after the IPO, Wedbush provided a $14 price target for Etsy, which was 55% below the stock price at the time and pointed to alleged counterfeit and copyright infringement of more than 5% of the merchandise on Etsy. Goldman Sachs and Morgan Stanley initiated neutral ratings, noting that the IPO price already baked in some potential upside. A disappointing Q1 report with decreased GMS and revenue growth rates raised investors' concerns about Etsy’s ability to maintain its historical growth rate and intensified decline in stock price that is now traded 10% below its initial IPO price.

A current price of $14.3 reflects a sane market cap for Etsy of $1.6B and a P/S ratio of 6.8, which is slightly above eBay’s current 4 P/S and Alibaba’s current 17.5 P/S. In my opinion, after 50% drop in stock price, Etsy is now a reasonable investment alternative in the e-commerce market; when Amazon and eBay were near their 52-week high, Etsy started to look like the reasonable, valuated kid on the block. But is ETSY a stock to buy?

If Etsy maintains its quarterly growth rates in every segment and continues to invest in emerging businesses like it did with the crowdfunding initiative, the company will generate annual revenues of $230M in 2015, which is an 18% year-over-year growth. Even though that YoY figure by itself might be impressive, for a small company with high risk compared to Amazon and eBay, 18% YoY growth is not enough, and investors will not take this unnecessary risk. As it has happened many times before, a stock can become unwanted very quickly and once that happens, the stock will keep on declining. Etsy is in such a position where the sentiment around the stock is strongly negative, and I do not believe any positive news, event or corporate action could lift the stock price above $16.

I think that investors should wait till Etsy hits rock bottom and becomes surprisingly undervalued at around $10-$12, from where it could bounce back up. For now, investing in Etsy might be a hazardous move to make.

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