Many investors looking for guidance have often turned to Peter Lynch. The former manager of the Fidelity Magellan Fund grew that fund from $18 million into $14 billion over 13 years.
Even though Lynch has retired from active fund management, some investors seek to apply his stock-picking principles to today's stocks. One stock that might match many tenets of Lynch's investment philosophy is Etsy (ETSY 1.44%).
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The company's value proposition
Lynch says that when investing, the most important organ is the stomach and not the brain. By mentioning the stomach, he is referring to an investor's ability to take losses.
Etsy has certainly tested investors' stomachs over its trading history. Since launching its IPO in 2015, the stock price has risen more than 330%. However, Etsy made many of its shareholders uneasy over the last year when it lost about 65% of value in a three-month timeframe.
Etsy stock has begun to rise from that 52-week low of just under $110 per share. Nonetheless, it still sells nearly 60% below its all-time high, leading many to question its value proposition.
That lower price could bring Lynch's favorite metric for evaluating stocks to the forefront, price-to-earnings-to-growth (PEG) ratio, to the forefront. This measures the P/E ratio versus the profit growth of a stock. With the PEG ratio, Lynch could look favorably upon a stock with a high P/E ratio if it also returned rapid profit growth.
Ideally, Lynch sought PEG ratios of one or below. While Etsy's current PEG ratio of 1.3 slightly exceeds that metric, it has fallen considerably from the PEG ratios above three that Etsy supported in 2019. At a forward P/E ratio of 32 and a forecasted 24% profit growth rate for the current year, the PEG could come close to one if Etsy continues its pattern of beating earnings expectations.
Etsy maintains an edge by targeting specific markets
Lynch also advises that if a company does well, stocks also tend to prosper, and vice versa. He cautions against viewing stocks as "lottery tickets" and instead counsels investors to look at the company.
He also advises investors to look for an "edge," or advantage found through analyzing the company or knowing the specific industry. Investors can find that edge in the solid business Etsy has built. It has attracted over 96 million buyers, and this interest in artisan goods can help investors evaluate Etsy.
Etsy also only accepts sellers who offer artisan goods, vintage products, or craft supplies. This has helped the company build a community based on buyers and sellers interested in these products. Low start-up costs and a search engine designed for buyers to find desired products add to the community's appeal.
Etsy benefits from a considerable addressable market
Still, the key to a potential recovery may lie in its addressable market. Lynch says that in baseball terms, one should consider buying in the "second or third inning" of a growth opportunity. For example, he mentions that Walmart only covered 15% of the U.S. in the early 1980s, noting that the stock rose 50-fold as it worked to bring that percentage to 100%.
Etsy holds the potential to follow a similar path. Its leaders believe the artisan and vintage goods it sells present a $2 trillion opportunity. From this standpoint, Etsy is only getting started. In 2021, Etsy generated more than $2.3 billion in revenue. Although this grew 35% compared with 2020 levels, it represents just over 0.1% of the estimated opportunity.
Investors should not assume revenue will get to $2 trillion anytime soon. Nonetheless, Etsy's approach has helped it compete against Amazon, indicating it should hold up well against prospective competitors.
Etsy as a Peter Lynch stock
Lynch has never publicly commented on Etsy, and admittedly, the stock's volatility over the last year likely tested the mettle of its shareholders. However, it has only begun to scratch the surface of its massive addressable market, and its PEG ratio at least brings it near a price Lynch might have paid. If Etsy is not exactly a Peter Lynch stock, it at least comes very close.
