Spotify (SPOT -7.28%) is one of the most well-known digital brands in the world, and for good reason. The music and audio streamer has grown rapidly over the last decade, and now has hundreds of millions of monthly active users (MAUs). However, even though its business has continued to chug along, the stock hasn't performed well this year. Its price is down 23.8% year to date while the broad market S&P 500 index is up by around 16%.
That decline might scare some investors away from Spotify, but to me, it looks like the market is providing a buying opportunity to anyone with a long-term mindset.
Here are four reasons to buy Spotify stock right now.
Image source: Getty Images.
1. There's a big secular tailwind in music streaming
At the end of the second quarter, Spotify had 365 million MAUs and 165 million subscribers to its premium ad-free music service. The company continues to ride the global transition from analog music listening (i.e. radio) to streaming and on-demand listening, and it has set a goal of hitting 1 billion users.
Given that there will be an estimated 7 billion smartphone users worldwide by 2030, the vast majority of whom will want to access music from their devices, Spotify has a clear path to that goal if it can maintain its current market share of 32% in music streaming. It is concerning that Spotify reportedly lost market share in the early part of this year to fast-growing competitors like Alphabet's YouTube Music and Amazon Music. This is something that investors should track, but with so many new users likely to join a music streaming service over the next decade (either paid or ad-supported, both of which Spotify offers), a slight decrease in market share will not be detrimental to Spotify's prospects.
2. Spotify is expanding into podcast advertising
In the past few years, Spotify has also started to offer other audio content like podcasts. It has invested heavily into the medium, buying studios like Parcast, licensing top shows like The Joe Rogan Experience, and acquiring distribution platforms Anchor and Megaphone. The goal is to get as many people as possible to listen to podcasts on Spotify so it can serve ads to them through its new podcast advertising network.
At the end of the second quarter, Spotify had 2.9 million podcast episodes on its platform and 91 million users listening to them. This, along with its acquisitions and the investments it has made in its advertising network, helped Spotify grow its podcast advertising revenue by 627% in Q2, albeit off of a small base. If this rapid growth can continue over the next few years, podcast advertising will likely become the second most important part of Spotify's business, the first being music streaming subscriptions.
3. Spotify is improving music discovery and promotions
One concern a lot of investors have with Spotify is that gross margins in music streaming are low. The company has to pay around two-thirds of every dollar it makes out to rightsholders like labels and artists, which is why its premium gross margin was only 30.8% last quarter. On a consolidated basis, Spotify will look to improve margins with podcast advertising, which doesn't have the same payout dynamics.
Within the music business, it is looking to expand its gross margins through new promotional tools that create what it calls the two-sided marketplace. For example, with Discovery Mode, artists can ask to have songs promoted within playlists and across the Spotify app, free of charge. The catch is that if a song does get played, Spotify takes a larger-than-normal cut of the artist's earnings. This is a win for consumers (who get presented with more new songs they might like), Spotify (which gets improved margins), and artists (who enhance their ability to reach new potential fans).
4. Spotify is trading at a reasonable valuation
After the stock's sell-off over the past year or so, investors can now buy shares of Spotify at a relatively discounted valuation. The company has a market cap of $45 billion and shares trade at a price-to-sales ratio of 4.4. Given the current low margins of Spotify's business, this isn't dirt cheap. However, considering the continued tailwinds in music streaming, its new podcast advertising revenue stream, and the expansion of gross margins coming from its two-sided marketplace, Spotify will likely have much higher annual sales and gross profits in the future. This could make the current stock price look like a steal a few years from now.
