Wednesday, October 5 2022

E– commerce is a vast industry. There are companies directly involved in the process, and facilitators like Sto hope (NYSE: SHOP) and Etsy (NASDAQ: ETSY). I think enablers make better investments because they generally have better margins and better insulation against what’s trending or not.

However, Shopify and Etsy have been terrible investments in 2022 after crushing the market for the past two years.

SHOP data by YCharts

With this type of selling, many investors may wonder if this is a solid entry opportunity, as both are still class leaders. So let’s take a look at their most recent financial results and see which is the best buy in today’s tumultuous market.

One-time effect influenced Etsy’s growth

First, a quick company overview: Shopify provides the software needed to run an e-commerce store, including inventory management, shipping logistics, payment processing, and a website. In exchange for using its software, Shopify charges its customers a flat monthly fee and takes a cut of each transaction.

Etsy is similar, except it focuses on extremely small operations that typically sell custom or handmade products. Through Etsy’s Marketplace, sellers can list their items and Etsy takes a cut of each transaction in return.

Both companies have experienced a massive boom during the pandemic. However, each now faces difficult comparisons. For example, in the second quarter, Etsy’s revenue increased 11% against a decline in gross merchandise sales (GMS) of 0.4%. This disconnect is due to the fact that Etsy increased its transaction rate from 5% to 6.5% at the start of the quarter, which caused some sellers to go on strike for a week.

Shopify’s revenue grew slightly faster at a 16% level, with gross merchandise volume (GMV) up 11%. For Shopify, its main driver of growth was its Merchant Solutions segment, which grew 18% year-over-year due to more customers adopting more of Shopify’s services.

Shopify is the clear winner when it comes to growth, as its growth has come organically compared to Etsy’s growth, mostly through a one-time increase. Etsy can only push its sellers so far before an alternative presents itself.

Winner: Shopify

Shopify spends like it’s going out of fashion

Getting down to the basics, it’s clear: Shopify spends a lot to promote and innovate its platform. Its expenses have increased significantly compared to a modest 16% growth in income:

Shopify’s second quarter annual spend growth
Sales and Marketing Research and development General and administrative
62% 89% 67%

Source: Shopify. YOY = year after year

As a Shopify investor, I don’t like to see this kind of disconnect between growth and spending. Although it was profitable in 2021 due to the effects of COVID, it no longer holds that designation. To partially address this and reduce expenses, Shopify laid off about 10% of its workforce. CEO and co-founder Tobi Lütke blamed himself for the overhiring mistake because he expected the COVID e-commerce gains to be permanent rather than reverting to the standard adoption curve.

Etsy’s earnings aren’t quite as messy. The company is profitable, although its net profit fell 26% year-on-year. However, its adjusted EBITDA margin has increased from 26% last year to 28% this year, so its cash flow is improving, a positive sign for investors. Still, Etsy’s operating expenses increased by 17%, which still worries me, but not nearly as much as Shopify’s expense growth rate.

Etsy has maintained profitability and has relatively good control over expenses, unlike Shopify. There’s no real argument in the competition for the more robust bottom line.

Winner: Etsy

The future

Perhaps the most critical segment of the overall comparison is what the future looks like for both companies. After all, this is what will determine future stock price movements.

Etsy’s most important growth catalyst is its burgeoning advertising business. Since the start of the year, sellers’ advertising budgets have increased by 80%, a growth that goes against conventional wisdom about advertising in a recession. Since Etsy controls the ads, it makes money from both ad sales and increased revenue, so this is a critical move for the business.

Shopify has many irons in the fire, but the one driving it from its roots is its point-of-sale (POS) offering, which grew 47% year-over-year. Point-of-sale systems are used in physical environments, not in e-commerce. However, if Shopify can establish its brand in this space, it holds significant revenue potential.

Additionally, Shopify Plus (which targets large enterprises) has signed Asics and HP during the quarter. Shopify’s improved logistics capabilities and international expansion were probably a big reason big brands like these two signed on, and these improvements will also bring significant value to existing customers.

Shopify has a bigger future ahead of it than Etsy, but that broad vision is also what’s driving Shopify to rapidly increase spending.

Winner: Shopify

What stock should you buy?

Although the tally is two points for Shopify and one for Etsy, there’s a lot more to be said for both companies. Etsy shares are trading at 6.5 times sales, less than Shopify’s 9.1 times, despite much better margins. This valuation gap is due to investor sentiment, as many people believe Shopify has a huge avenue for growth.

Shopify’s track is probably bigger, but if it fails, the downside will be much less than Etsy’s. If you’re investing in these companies for the next three to five years, it’s hard to ignore Shopify’s potential, but its business has shown some weakness lately.

Choosing the best stock ultimately comes down to your risk tolerance. Etsy is the low risk game, but it has a limited upside. Shopify is the exact opposite. Nevertheless, both are solid companies and investors should choose accordingly.

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Keithen Drury holds positions at Etsy and Shopify. The Motley Fool holds posts and endorses Etsy, HP, and Shopify. The Motley Fool recommends the following options: $1140 January 2023 Long Calls on Shopify and $1160 January 2023 Short Calls on Shopify. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


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