3 things you need to know about Etsy before you buy inventory

Investors looking to gain exposure to the e-commerce industry most likely have Amazon at the top of their lists. The $1.7 trillion tech giant dominates online shopping.

However, Etsy (ETSY 1.36%)a much smaller enterprise by comparison may also catch your eye. It has successfully carved a niche for itself in the large e-commerce space. If you’re thinking about buying stocks, know these three things first.

1. Hard times

When consumers were spending more money and time online than ever before, Etsy was firing on all cylinders during the COVID-19 pandemic. But things have slowed considerably since then, and now the company has fallen on hard times.

During the second quarter (ended June 30), Etsy’s core marketplace reported a 3.2% decline in gross merchandise sales (GMS) compared to the year-ago period. It marked the third consecutive quarter of decline, and management expects more pressure in Q3.

Etsy’s top product categories are things like home furnishings, jewelry, and clothing. These can be described as non-essential discretionary purchases. When there are inflationary pressures along with general economic uncertainty, it makes sense for consumers to be a little more cautious with their spending.

It’s not all bad news, though. The Consumer price index decreased to more normal levels. And there is a possibility that the Federal Reserve will start cutting interest rates in September. This could provide a much-needed boost to Etsy’s GMS growth.

2. Network effects

Etsy has one economic moat. This term, made famous by the great Warren Buffett, indicates that a business has some kind of sustainable competitive advantage that helps protect it from the threat of existing industry rivals and new entrants. It is an important feature that defines a high-quality enterprise and enhances its sustainability.

The presence of the mighty network effects it’s the basis of Etsy’s moat. Etsy operates a two-sided online marketplace. As of June 30, it had 96.6 million active buyers and 8.8 million active sellers. As more buyers join, the number of potential customers increases and Etsy becomes more valuable to sellers. And as more sellers join, buyers have a wider range of options. Consequently, the platform becomes better for all stakeholders over time.

Just imagine what it would take to start a competing online marketplace from scratch. Not only should you attract buyers without having any merchandise to sell, but you should also connect with merchants without having buyers. This gives me confidence that Etsy probably won’t be disrupted anytime soon.

3. Cheap stock

Etsy was once a Wall Street darling. In the five years leading up to the peak, the stock skyrocketed 2,160%. Then, a combination of slower growth in the wake of the pandemic and the market’s disdain for high-flying tech stocks hurt Etsy shareholders.

The stock is currently trading 81% off its all-time high. And while Nasdaq Composite andindex is up 59% since the start of 2023, Etsy shares are down 54% (as of Aug. 7).

But there is an opportunity here for patient investors. At a the forward price-earnings ratio of 12.3, Etsy trades at a very cheap valuation. This demonstrates the market’s extreme pessimism about this business.

If you think Etsy will return to posting solid revenue and earnings growth, this could be a great time to buy the stock.