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E-Commerce Stocks Crushed It in 2017. Will 2018 Be a Repeat?

Jeremy Bowman, The Motley Fool

2017 was a banner year for the U.S. stock market as all three major indexes gained at least 19%, but e-commerce stocks may have been the biggest winners of them all.

Among stocks in the sector that soared were major online retailers like Amazon.com (NASDAQ: AMZN), smaller ones like Etsy (NASDAQ: ETSY), and key suppliers like XPO Logistics (NYSE: XPO), and Shopify (NYSE: SHOP). The chart below shows last year's performance of some popular e-commerce plays.

AMZN Chart

AMZN data by YCharts

The stocks above gained in part due to individual circumstances. Etsy, for example, got a new CEO as activist investors pounced on the stock, and XPO Logistics shares spiked after Home Depot considered acquiring the company. But more broadly, investors' optimism about the possibilities for the industry grew, driving the whole sector higher. 

Some of these companies are enjoying incredible revenue growth, such as Shopify, which saw a 72% top-line increase in its most recent quarter, and MercadoLibre (NASDAQ: MELI), where revenue jumped 60%.

However, with valuations already stretched, can investors expect another year of outperformance from e-commerce stocks?

A delivery man holding several boxes while another man signs for them.

Image source: Getty Images.

The big picture 

The share of retail sales that go to e-commerce has been steadily growing for years, and total U.S. online sales have increased about 15% annually since the financial crisis. As of the third quarter of 2017, e-commerce accounted for 9.1% of total retail sales, according to the Census Bureau.  Based on that figure, it's easy to see why e-commerce is viewed as having such a long growth path ahead of it. Even if online sales doubled, they would still amount to less than 20% of the total. And U.S. retail sales hit $5 trillion last year, or $5.7 trillion when restaurants and bars are included. In other words, there may be no greater business opportunity in the world. It's no wonder Amazon, the industry leader, is one of the most valuable companies in the world and still growing fast. 

However, nobody should expect that all store-based sales will eventually  shift to online channels. Sectors like supermarkets, home improvement, and restaurants have proven difficult to disrupt, although major players in those sectors like Walmart, Home Depot, and Starbucks are rapidly embracing e-commerce.  And of course, there are categories like gasoline, which accounted for $455 billion in sales last year, where e-commerce's delivery model is just not practical.

Still, the opportunity to convert traditional retail sales to the online channel is broad, and it's reasonable to expect that to continue driving e-commerce sales up by 15% or so every year for the foreseeable future.

The Amazon effect

One other key factor that investors should consider is Amazon. Just as the e-commerce giant has leveled traditional retailers, it's also threatened its e-commerce peers. For instance, it's introduced Amazon Handmade, its competitor to Etsy, and has entered restaurant delivery, potentially peeling away customers from GrubHub (NYSE: GRUB), the leader in online restaurant ordering.  At one point, Amazon had its own Shopify competitor, Amazon Webstore, but eventually shut it down, saying it would partner with Shopify instead, and its move into the Brazilian market shook MercadoLibre. With its plans to build its own shipping fleet, Amazon could even one day challenge XPO Logistics, the leader in last-mile delivery.

What investors therefore need to keep in mind is that while the industry as a whole will see significant growth, the segments within it may be zero-sum as pure-play companies like GrubHub and Etsy battle it out with Amazon. That means that investing in a pool of e-commerce stocks may be a better way to play the sector than just buying one or two.  

The valuation question 

As the chart below shows, P/E ratios climbed for most of these stocks last year, as their stock price gains were based more on growing revenues and market enthusiasm than in jumps in profits. 

AMZN PE Ratio (TTM) Chart

AMZN PE Ratio (TTM) data by YCharts

However, when it comes to companies like Amazon, investors have shown that if a business's competitive advantages are strong enough,  they're willing to accepts such ambitious valuations. I also tend to agree with my colleague Brian Stoffel, who argues that optionality and moats are more important considerations than valuations, especially in a bull markets when growth stocks tend to outperform more defensive plays as investors don't want to miss out on big gains.

Given that the global and U.S. economies are finally operating at full capacity and stocks are already off to a strong start, 2018 is shaping to be another good year for e-commerce stocks.

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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Jeremy Bowman has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Amazon, MercadoLibre, and Shopify. The Motley Fool recommends Etsy and XPO Logistics. The Motley Fool has a disclosure policy.