One of my favorite quick and easy ways to tell if a growth stock qualifies as “value” or not is to compare its price to free cash flow (P/FCF) ratio with its annual sales growth. . rate. Whenever a company’s sales growth is greater than its P/FCF multiple, it catches my eye because it highlights a strong rate of expansion at a reasonable price.
One of these companies specializes in e-commerce Etsy (NASDAQ: ETSY), with a P/FCF of around 31 and annual revenue growth of 62%. At first glance, these numbers look incredibly promising and make Etsy look like a screaming buy. However, during the third quarter, its year-over-year sales growth slowed to 18%, which leaves me wondering: Has Etsy become a value stock?
Is the growth deceleration here to stay?
Etsy will release its fourth quarter results on February 24, and quarterly gross merchandise volume and sales growth will be of utmost importance to investors. When the pandemic began, the global acceleration of e-commerce propelled Etsy’s growth for years. As a result, the company recorded triple-digit percentage sales growth in late 2020 and early 2021. But now it’s exceeding those periods, making comparisons difficult.
Analysts expect to hear fourth-quarter sales rose just 11% to around $685 million, and Etsy’s share price decline reflects market concerns that days strong growth of the company are behind it.
However, gross merchandise volume per active buyer increased 20% year-over-year in the third quarter on the back of higher average order value and increased order frequency, underscoring that its measure of value customer lifetime improves.
Additionally, the upcoming earnings call will be Etsy’s first with a full quarter of news from its Reverb, Elo7 and Depop acquisitions, making this report exceptionally important for long-term investors.
Elo7 offers valuable exposure to the Latin American e-commerce market, while Depop caters to Gen Z, a younger demographic than Etsy’s core user base. Even better, Depop operates in the apparel resale industry, which is expected to grow five times faster than the broader apparel market through 2025.
Ultimately, these decelerating sales growth numbers show that the company’s annualized revenue growth rate of 62% may be misleading due to its pandemic-aided spike. However, its P/FCF ratio is only 31, and Etsy could quickly exceed that valuation if it continues to post gross merchandise volume growth of 20% or more for an extended period.
Etsy’s price drop to free cash flow
This P/FCF of 31 is down from a high of around 75 in 2021 – a drop that reflects investor concerns about Etsy’s slowing growth.
With that multiple down by more than half, and despite its slightly lower free cash flow generation, Etsy started trading closer to value territory. However, the FCF figure in Etsy’s next revenue report will be crucial as it is in the fourth quarter of 2020, which saw a whopping $240 million in FCF.
The mere fact that it continues to integrate and invest in its Elo7 and Depop acquisitions, which will weigh on its margins for the foreseeable future, further complicates the image of Etsy’s valuable FCF generation.
Ultimately, Etsy may not be the glaring value stock that its P/FCF of 31 and annual sales growth of 62% make it appear, but it still has an incredibly strong investment thesis to long term. With its 26% free cash flow margin, promising recent acquisitions, and strong organic growth through its existing customer base, now might be a good time to consider opening a position on Etsy or add one.
While decelerating growth and slowing FCF generation might seem like a deal breaker for its investment thesis, I think those numbers represent how Etsy thrived at the start of the pandemic — rather than showing real flaws in its current operations.
This article represents the opinion of the author, who may disagree with the “official” recommendation position of a high-end advice service Motley Fool. We are heterogeneous! Challenging an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and wealthier.