Will the High Level of Risk in Etsy Stock Pay Off for Investors?

By Markets Fool.com

Etsy soared last month after making its stock market debut. Investors welcomed the niche online retailer by pushing its shares up as much as 87% during the stock's first day of trading. Etsy, which priced its initial public offering at $16 per share, finished the day with a stock price of $30 -- making it one of the best performing IPOs so far this year. Investors have since taken some money off the table, sending the stock down to where it is trading today at around $23 a share.

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Etsy stands out in the increasingly crowded e-commerce space today thanks to its unique corporate culture and close-knit online community of buyers and sellers. Unlike other e-tailers such as Amazon.com , Etsy sells handmade one-of-a-kind goods that can't be found elsewhere. Etsy also differs from Amazon in the way it treats its third-party sellers. While Amazon's transaction fees start at a minimum of $1.00, they can cost a seller as much as 25% of the product's selling price. This approach has tarnished Amazon's relationship with some of its sellers in recent years.

Etsy, on the other hand, is more transparent about what it charges third-party sellers on its e-commerce platform. The Brooklyn-based e-tailer takes a 3.5% fee of each transaction as well as a listing fee of $0.20 per item. As of December, there were 1.4 million active sellers using Etsy.com to sell handcrafted products to 54 million Etsy members around the world.

Moreover, to prove just how seller-friendly the company is, Etsy offered its vendors and individual investors the chance to buy up to $2,500 worth of stock ahead of its IPO last month. That's not something you see every day on Wall Street. However, as generous as this move was, it underscores some of the risk in Etsy stock today.

Homemade, with a side of uncertainty
In 2014, Etsy generated revenue of $196 million, amounting to sales growth of more than 56% year over year. Etsy's sellers, meanwhile, produced gross merchandise sales north of $1.9 billion that year. However, don't confuse these impressive figures with profitability. A closer look at the company's prospectus tells us Etsy has not yet turned a profit. In fact, the online marketplace has reported consecutive net losses since fiscal 2012. This is a troubling reality for a stock that's now trading at 91 times next year's forecasted earnings.

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Source: Etsy/Instagram.

Etsy posted $15 million in net losses last year, up from less than $1 million the prior year. Plenty of companies make their public market debuts not yet having reported a profit. However, Etsy's commitment to its values as a socially responsible company could distract the e-tailer from focusing its resources on near-term profitability. In Etsy's prospectus, management warns:

"We may take actions, such as investing in alternative forms of shipping or locating our servers in low-impact data centers, that reduce our environmental footprint even though these actions may be more costly than other alternatives."

If this seems like a strange dynamic for a publicly traded company, you're not wrong. Etsy is registered as a B Corp, which means it's recognized as a socially responsible company. As such, Etsy is only the second so-called B Corp to ever become a public company. These motives are undoubtedly admirable. Yet shareholders need to know that the company has their best interests at heart as well.

Nevertheless, I believe this distinction could work to Etsy's benefit. Etsy already has a strong customer base and loyal following, with more than 19 million consumers actively shopping the e-commerce platform today. Moreover, recent studies suggest that an increasing number of consumers prefer to purchase goods from companies with sustainable environmental and labor practices. Ultimately, Etsy's pledge to have a positive impact on local communities and the world should only strengthen its brand value in the years ahead.

Source: Etsy/Instagram.

The specialty retailer's accounting practices are another potential red flag for investors. In its prospectus, Etsy notes: "We have identified two material weaknesses in our internal control over financial reporting that, if not corrected, could result in material misstatements of our financial statements."

Etsy is hardly the first company to hit the public market without the correct financial procedures in place (cough, Groupon, cough). The good news is that Etsy has already identified the problem and is working to rectify it. Therefore, while investors should keep an eye on this matter, it isn't something that poses a long-term threat to the company.

Striking a balance
All of these risks bring a level of uncertainty into Etsy's investment thesis. However, the company's goal of reimagining e-commerce in ways that benefit both local communities and the world is also one of Etsy's greatest competitive advantages. With the global online retail market set to top $1.5 trillion by 2018, there's no shortage of opportunities for Etsy and its offbeat business plan. Therefore, I suspect the company's decision to do business in ways that are unique and can have a positive impact will ultimately outweigh the inherent risk in the stock.

The article Will the High Level of Risk in Etsy Stock Pay Off for Investors? originally appeared on Fool.com.

Tamara Rutter owns shares of Amazon.com and plans to purchase shares of Etsy. The Motley Fool recommends Amazon.com. The Motley Fool owns shares of Amazon.com and Etsy,. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.