Etsy (NASDAQ:ETSY) stock peaked out in early August at about $135.52 and then it went on a month-long slide. It seems to have bottomed out recently around $108 or so. Now it looks like a reasonably good buy here.
Around the time of last month’s peak, I wrote that ETSY stock, after having a monster year, was almost certainly overdone. At the time it had more than doubled. I felt that although it had significantly beat expectations in sales and earnings (actually EBITDA, earnings before interest, taxes, depreciation and amortization), it was overvalued.
Moreover, it just seemed logical to me that investors would likely begin to take profits made in the stock over the past year. You almost get a sense of it.
I always believe that you have to have a margin of safety in your stock purchases. Otherwise, what is the point of average costing into a position?
Now that investor sentiment has cooled off a bit on ETSY stock, we can take a closer look at where it might end up over the next year or so.
Time to Buy Etsy Stock
Barron’s Teresa Rivas wrote several days ago that now is the time to buy the dip in ETSY stock. She quoted BTIG analyst Marvin Fong who said that ETSY is “one of the few e-commerce stocks that one can make a valuation argument with a straight face.”
That is pretty funny. I like that. He’s referring to the $222 million in EBTDA that ETSY made in the last 12 months (LTM) to June 30. In addition, it made almost $352 million in free cash flow in the LTM to June 30. There are very few e-commerce stocks that have that kind of profitability.
More importantly its FCF margin is exploding. For example, the LTM margin was 31.2%. But in the latest quarter, Etsy made $220.8 million in FCF from $428.7 million in sales. That represents a FCF margin of 51.50%. This is 65% higher than the LTM margin of 31%.
In other words, profitability is accelerating. So you can imagine, analysts are going crazy over this. At a recent market capitalization of $13 billion or so. If it makes $880 million in FCF (i.e., $220 million last quarter x 4), that represents a FCF yield of 6.76%. That is a decent yield.
Another way to look at is that the stock trades for just 14.8 times its FCF. Typically companies with that high an FCF margin will trade at twice that valuation.
Barron’s also quoted Etsy CFO Rachel Glaser in another article saying that its growth came from more than just masks. She argues that the Etsy shopper is becoming more used to online shopping and that her marketplace is a direct beneficiary of that movement. Glaser added that the cohort of Etsy shoppers who buy more than six times a year grew 64% in the quarter.
Hitting Only 2% of Addressable Market
Etsy says that its total addressable market is at least $100 billion. In 2021 sales are forecast to be $1.7 billion, $202 million more than in 2020. So it still has less than 2% market share of what it believes it is its playground.
Therefore, expect big things for the company over the next five years. For example, assuming its FCF margin grows to 55% and sales grow at 13.3%, FCF will be $2.8 billion and FCF will be $1.54 billion.
At a 5% FCF yield that would give ETSY stock a market cap of $30.9 billion, or a gain of 137% in five years. On a compound basis, that means the stock would rise 19% per year over that period.
But I suspect that the market will love this performance and likely give it a 3% FCF margin. That represents a price-to-FCF ratio of 33x. At that multiple, the market value would be $51.3 billion, or almost 4x that recent $13 billion market value.
Moreover this would be an annual return for investors of 31.6% each year, on a compound basis. That is an astounding return that most investors would be happy to accept. Especially so, since the company would be making real cash profits, which is often missing in markets today.
Here is the bottom line: ETSY stock looks like a bargain today given its impressive financial performance, which is likely to continue.
As of this writing, Mark Hake, CFA does not hold a position in any of the aforementioned securities. Mark Hake runs the Total Yield Value Guide, which you can review here.
