Why Etsy's Stock Drop Could Lead to Unexpected Gains Ahead

Is Etsy Set for a Comeback After Leaving the Index?

Often, when a company gets removed from the S&P 500 index, investors shy away, considering it a sign to avoid the stock. However, a study conducted by Research Affiliates suggests otherwise. Their analysis reveals that stocks previously listed in major indexes like S&P 500, Nasdaq-100, and Russell 2000 often surpass the broader market in terms of performance over the next few years.

According to their research spanning from 1991 to 2018, stocks that were removed from such indexes outperformed the market by an annual average of five percentage points within five years. This finding may come as a surprise to many and goes against instinctive caution surrounding delisted stocks.

Understanding the Value in Removal

It might be counterintuitive, but the reasoning behind this performance trend is clear. When a stock is announced to be exiting an index, it typically experiences a significant sell-off. This causes the stock to hit "value" pricing territory, where it becomes more attractive to discerning investors. As the stock price drops, the pressure to generate outstanding returns also diminishes, making future gains more attainable.

One notable company that has recently exited the S&P 500 is Etsy (NASDAQ: ETSY), known for its creativity-centric e-commerce platform. Given historical data suggesting a potential rebound for such stocks, Etsy presents an intriguing case for investors seeking value.

An Overview of Etsy's Performance

Etsy operates with a unique business model, connecting around 9 million sellers with 96 million active buyers. The platform's mission focuses on keeping commerce human, fostering an environment where small businesses can thrive. With 97% of its sellers operating from home, the personalized, often handcrafted products from Etsy starkly contrast mass-produced items found on giants like Amazon and Walmart.

Since 2017, Etsy's sales and free cash flow (FCF) have surged impressively, increasing by 36% and 42% annually, respectively. However, this growth wasn't achieved without turbulence. During the pandemic, Etsy enjoyed a dramatic spike in sales driven by homemade masks and a shift towards online shopping. Despite the pandemic-induced boom, the company has faced challenges in maintaining that growth trajectory, leading to a substantial drop in market capitalization from over $30 billion to approximately $6 billion, ultimately resulting in its removal from the S&P 500.

Analyzing Indicators of Future Success

Despite these setbacks, several factors suggest Etsy might still excel in the coming years. One notable metric is Etsy's cash return on invested capital (ROIC), which stands proudly at 40%. This figure positions the company well against its peers in the S&P 500, showcasing its efficiency in generating revenue relative to its investments.

The company's solid FCF margin of 25% has fueled aggressive share buybacks, reducing its share count by 9% over the last three years. Historically, companies like Etsy with high FCF generation and active share repurchase programs have outperformed the market by an impressive 5.5 percentage points annually from 2000 to 2019, as reported by S&P Global.

The Importance of Mobile Engagement

Another critical area for improvement for Etsy lies in its mobile app. Currently, only 45% of Etsy's buyers utilize the app, leaving a significant opportunity for growth. In contrast, most millennial consumers already have the Amazon app, highlighting a competitive gap. If Etsy can convert more of its users to using the mobile app, it could spur even greater engagement, as those who shop via mobile generate nearly twice the purchase frequency.

A Unique Valuation Offer

With Etsy's stock down 82% from its peak, its free cash flow yield now stands at 9.6%, marking the highest level in ten years. Even accounting for stock-based compensation, Etsy trades at a mere 15 times its FCF—approximately half the valuation seen in the average S&P 500 stock.

If Etsy can succeed in bolstering its mobile app engagement and improve its overall user experience and international reaching capabilities, it may rapidly outpace this current valuation. In the event that its stock remains undervalued for an extended period, the shares repurchased at lower prices could enhance the stock's value when the market recognizes Etsy's true worth.

A Wrap-up on Etsy and Future Prospects

In conclusion, while Etsy's journey has had its ups and downs, it has emerged as a robust cash-generating entity that should not be overlooked, especially following its exit from the S&P 500. The historical trends suggest a positive outcome for buyers, especially given the current value proposition of the stock.

Frequently Asked Questions

What does it mean for Etsy to leave the S&P 500?

Leaving the S&P 500 can initially seem negative, but historical data suggests that stocks removed from major indexes often see a rebound due to price corrections.

How has Etsy performed financially since its inception?

Etsy has seen substantial growth since 2017, with annual increases in sales and free cash flow of 36% and 42%, respectively.

What is Etsy's current market position?

Etsy holds a strong market position with a unique business model that emphasizes personalized, handcrafted products compared to mass-market retailers like Amazon.

Why is mobile engagement essential for Etsy?

Boosting mobile app engagement is vital, as mobile users typically make purchases more frequently, translating into higher sales for the company.

Is it a good time to invest in Etsy?

Given Etsy's current valuation and historical performance trends indicating a potential rebound, it may be an opportune time for investors to consider.

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Disclaimer: The content of this article is solely for general informational purposes only; it does not represent legal, financial, or investment advice. Investors Hangout does not offer financial advice; the author is not a licensed financial advisor. Consult a qualified advisor before making any financial or investment decisions based on this article. The author's interpretation of publicly available data shapes the opinions presented here; as a result, they should not be taken as advice to purchase, sell, or hold any securities mentioned or any other investments. The author does not guarantee the accuracy, completeness, or timeliness of any material, providing it "as is." Information and market conditions may change; past performance is not indicative of future outcomes. If any of the material offered here is inaccurate, please contact us for corrections.