Down 76%, Should You Buy the Dip on Etsy?

During the five-year period leading up to their all-time high, Etsy (NASDAQ: ETSY) shares had soared an impressive 2,160%. The company was doing well before the pandemic, but the health crisis supercharged spending on the online marketplace, leading to soaring revenue and earnings.

Since then, Etsy has shown that what goes up, must come down. The business has struggled to drive meaningful growth in recent years. And the market is worried. The e-commerce stock currently trades 76% below its peak from nearly four years ago (as of Oct. 8). At this point, the company might be a prime target for contrarian investors.

Should you buy the dip on Etsy stock right now?

Shareholders want something to be excited about

On Sept. 29, Etsy shares were up 16% on the day after news broke that OpenAI's ChatGPT launched Instant Checkout. This feature allows U.S. users of the popular AI chatbot to purchase single items from Etsy directly through ChatGPT. OpenAI will collect fees in the process.

It's not clear yet how much of an impact this will have on Etsy's business. It could widen the funnel, as ChatGPT counts a whopping 700 million weekly active users. This could help drive motivated shoppers to the Etsy platform, especially those that might not already be familiar with the online marketplace.

Etsy stock popped on the news. But it sold off the following day. Nonetheless, shares are up 31% in the past month, so investors are starting to view the company in a more favorable light.

But it will be a challenging task to keep the bullishness going, as the business has struggled in recent years thanks to slowing growth. Gross merchandise sales (GMS) totaled $2.8 billion in Q2 (ended June 30), lower than the sum exactly four years before.

On paper, Etsy looks like a fine business

Regardless of what the stock might indicate, there are factors that make Etsy look like a high-quality business.

It provides a differentiated shopping experience, with a marketplace that sells unique, vintage, and handcrafted goods. A survey conducted by the company in 2023 found that 83% of Etsy buyers said the site has merchandise that they can't find anywhere else. That helps Etsy stand out in the competitive retail sector.

As a two-sided marketplace, with 93.3 million active buyers and 8.1 million active sellers, Etsy benefits from a powerful network effect that's global in nature. More sellers who post more items makes the platform valuable to shoppers looking for a wide selection to choose from. And more shoppers introduce a larger customer base for sellers to target. In theory, the site's value proposition should improve as it scales up.

Additionally, Etsy has a history of consistent profitability. It generated $76.4 million in operating income in the last three months. And the operating margin has averaged 16.1% in the past five years. Management has been able to use free cash flow that's generated to repurchase shares.

Speaking of the shares, they trade at a beaten-down valuation. Investors can buy the stock by paying a price-to-sales multiple of 3, close to the lowest level in the past decade. The market has low expectations for the business, and rightfully so.

This is a risky bet to make

Etsy has successfully carved out a niche in the e-commerce industry. It has positive attributes. And the shares are cheap. But even though the stock is trading well off its peak, investors are staring at a risky proposition.

Etsy's biggest challenge has been to grow its user base, GMS, and revenue during a time when the broader economy has generally been healthy. The business has a hard time driving repeat purchase behavior and pushing shoppers to spend on the site more frequently than that special occasion once in a blue moon.

Until the company's fundamentals start to improve, investors should stay away from the stock.

Neil Patel has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Etsy. The Motley Fool has a disclosure policy.