If you bought shares of an e-commerce company Etsy (ETSY) -3.85%) In November 2021, you probably wish you had bought an index fund. Etsy shares have plunged 63% since then, while the market is only down 18%. Buying an index fund instead of Etsy stock would have saved him big losses.
Etsy is not an anomaly – you could easily create a list of high-quality companies where stocks are trading at 70%, 80%, and even 90% off their peak values. And my observation is that investors are becoming discouraged as a result. In desperation, they are giving up picking individual stocks and simply investing in index funds.
Don’t get me wrong: index funds can be a great approach to building long-term wealth. And they can constitute part or all of an investment plan. However, I emphatically believe you they can outperform the average market return by choosing stocks. And if you don’t agree with me now, I think a quote from the CEO of Etsy will completely change your perspective.
Losers are getting kicked out
Decades ago, Etsy CEO Josh Silverman ran an internet startup called Evita. When Silverman joined in the late 1990s, it was the golden age for Internet startups.
Silverman recalled the dotcom era in the ever core ISI Technology Conference on September 7th and dropped this golden nugget of wisdom: “I’m old enough to have been running a business in the year 2000 when all Internet companies made endless amounts of money. And in fact, 2002, 2003, 2004, 2005 were some of the best times to build Internet companies.”
Silverman says that financing Internet businesses was easy during what is now known as the dot-com bubble. However, when the bubble burst in 2000, the funding evaporated. But Silverman says the best time to build was after the free money disappeared.
When debt is cheap, companies with bad deals, poor management, and dodgy opportunities can finance their operations and grow like good companies. But once the music stops, the bad investments are finally exposed for what they are.
For this reason, Silverman says that the best time to build is after the funding is gone. His comments were specifically in the context of electronic commerce. And history supports the idea of him.
Two dot-com survivors, Amazon Y eBay, saw its revenue continue to skyrocket before and after the crash, while many weak e-commerce players began to wither as their funds were pulled offline. A third survivor is stock reservation (then Priceline.com). And although his income fell for several years, eventually it grew again.
AMZN Income (TTM) data by YGraphics. TTM = last 12 months.
Time to buy the winners
I’m not here to tell you that stocks are necessarily undervalued right now or that your holdings will quickly rebound to all-time highs. I’m here to say that buying and holding individual stocks in good companies is a particularly compelling strategy for outperforming the market’s average returns from here.
As you probably know, the Federal Reserve has been raising interest rates to fight inflation, as reflected in the 10-year Treasury rates.
10-year Treasury rate data by YGraphics.
The impact this has on companies, both public Y private — it’s real. Nap CEO Evan Spiegel put it perfectly in a memo to employees: “Today, the cost of capital has risen so dramatically that our business will be valued based on our ability to generate profits. We must adapt our strategy accordingly.” The bottom line here is that Snap’s change in strategy is directly related to the ongoing change in the cost of capital.
Some companies are simply not ready to drastically modify their strategies and turn a profit. Those companies will be weakened or eliminated altogether, leaving only the best and strongest companies to gobble up market share from here. As an investor, if you can identify a handful of those companies now, I think you’ll do quite well if you buy their stock today.
Going back to where Etsy started, it’s positioned to do well in 2022 and beyond. It has a net debt position of nearly $2.3 billion in long-term debt compared to nearly $1 billion in cash, cash equivalents and long-term investments. However, its operations generate cash. During the first half of 2022, it generated $185 million in cash from operating activities. In other words, Etsy doesn’t need to worry about the cost of capital rising because it doesn’t need capital from outside sources.
Etsy’s smaller, privately owned competitors are not in the same position. At the Evercore conference, Silverman also said, “I think we’re going to see a reckoning.”
This benefits a solid company like Etsy. But the broader takeaway is not to give up stock picking while the market is down. Now may be one of the best times in years to invest in strong long-term companies.
John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Jon Quast has positions on Amazon and Etsy. The Motley Fool has positions and recommends Amazon, Booking Holdings and Etsy. The Motley Fool recommends eBay and recommends the following options: October 2022 $50 Short Calls on eBay. The Motley Fool has a disclosure policy.
