Spotify stock (SPOT) - Get Spotify Technology SA Report has been declining since the beginning of the year, accumulating losses of more than 10%. However, for some analysts, one catalyst could be a game changer: Spotify starting to turn a profit for shareholders.
Not unlike the rest of the streaming industry, Spotify is in an environment of high growth expectations, which helps to justify the stock’s rich multiples and high market expectations for future financial results. Below, we talk about the balance between growing profits and stretched valuations.
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According to analysts, Spotify should start to produce steady profits in 2022. In the first quarter of the year, the company is projected to deliver an EPS of $0.20. From there, consensus points at rapid profit growth: EPS of $0.60 in Q3 of next year, three times larger than in Q1 of 2022.
What do the multiples say?
The “catch” is that the stock seems to be already priced aggressively for the expected EPS ramp up. SPOT’s multiples are vastly higher than those of its peers (see table below). On the surface, the valuation premium on SPOT might discourage potential investors from considering this name.
It is worth noting, however, that the stratospheric valuation multiple is consistent with a period of transition from consistent losses to profits. Once EBITDA climbs further away from zero or negative, SPOT’s valuation may start to look more reasonable.
Possible scenarios ahead
In our view, the best scenario for the company is one in which it can (1) consistently increase its ARPU, or average revenue per user, and (2) expand geographically across the globe without losing price competitiveness. To accomplish this goal, Spotify has the benefit of already being a top player in the audio streaming industry, one that seems to be less crowded than the video space.
However, not all is upside for the company. As the world recovers from the COVID-19 crisis, growth in Spotify’s subscriber base could slow down and stabilize at a lower level. Also, continued investment in audio and music from heavyweights like Amazon (AMZN) - Get Amazon.com, Inc. Report and Apple (AAPL) - Get Apple Inc. Report could also become a threat.
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We subscribe to the idea that Spotify will likely see its profits climb rapidly in the next few years. However, that alone does not ensure that the stock is a “no brainer” today. Investors should consider the rich valuation multiples and decide whether they still allow for potential upside in the stock.
Spotify is projected to start delivering profits in 2022, rather than a loss. As EPS could climb aggressively in the next few years, do you think that the stratospheric valuation multiples today are justified?
Is the price right?
Looking at a company’s business fundamentals is only half the work needed to find a good stock. How much one pays to own the shares is a key factor in the success of any investment. This is why valuation analysis is so important.
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(Disclaimers: this is not investment advice. The author may be long one or more stocks mentioned in this report. Also, the article may contain affiliate links. These partnerships do not influence editorial content. Thanks for supporting MavenFlix)