Even After a Big Selloff, Tread Lightly With Etsy Stock...for Now

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It's been a great year for owners of online marketplace Etsy (NASDAQ: ETSY). Even after recent turbulence in the broader stock market, shares are up 130% -- continuing the steady climb that commenced in earnest after CEO Josh Silverman took the reins in 2017.

While it might be tempting to chase this stock, or even buy the recent dip, I'm sitting on my hands for the time being.

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Two catalysts, one big result

Etsy's business has accelerated over the last few years, and things only continued to improve in 2018. Consumers have been spending a lot more money (retail sales were up 5.3% over 2017 through November, according to the U.S. Census Bureau), and many are still making the switch to online shopping (online retail increased 10.4% over 2017 during the same period).

That has been a boon for Etsy, which decided to use the strong retail environment back in July to raise its transaction fee from 3.5% to 5% of the value of items sold. There was risk that merchants using the Etsy platform might flee, but the company still costs less to use than its closest competition. The result of strong consumer spending and the fee hike has been a big jump in year-to-date results:

After a great run, things could begin to slow in 2019, though. Estimates indicate that U.S. economic growth could moderate next year, and Etsy's pace of expansion could decelerate as well.

Momentum is key

As a high-growth company, Etsy's price movement is characterized by momentum -- any signs of a slowdown can cause wild swings in the stock. That's because its valuation is steep and prices in (i.e. factors in) continued strong growth. Even after its shares pulled back nearly 20% from recent highs, Etsy's trailing-12-month price to earnings (PE) ratio and forward PE ratio sit at 72.7 and 61.5, respectively.

Things look a little better when using price to free cash flow -- which is currently at 51.1 -- but paying for half a century's worth of profit is still a steep price tag. The slightest miss in expectations could send shares tumbling again, and after a vigorous year of consumer spending, that could be in the cards in 2019.

Plus, as Etsy gets bigger, new additions to its marketplace of sellers and buyers are slowing over time. From the beginning of 2018 to date, the number of active sellers on Etsy's platform is up 8% year over year, compared with increases of 11.8% and 10.6% in 2016 and 2017, respectively. Growth in the number of active buyers has reaccelerated slightly this year, up 17.2% compared with 16.8% in 2017 and 18.8% in 2016; nevertheless, it seems that most of Etsy's extra growth in the last few quarters has a lot to do with that transaction fee increase.

Thus, while Etsy's rise in the last couple of years has marked a great run, I'm choosing to wait on a purchase until the stock's valuation is less frothy.

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Nicholas Rossolillo and his clients have no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Etsy. The Motley Fool has a disclosure policy.