Spotify(NYSE: SPOT) is the world's largest music streaming platform. Its stock has been on a tear this year with a 142% gain so far, which crushes the 23% return in the S&P 500(SNPINDEX: ^GSPC).
Record subscriber numbers, strong revenue growth, and surging profits have been contributing factors to the incredible move in Spotify stock. The company's long-term forecast suggests it still has significant room for growth, which could drive even further returns for investors in the coming years.
However, Spotify stock is starting to look expensive following its powerful rally, so is it too late to buy?
Leaning into new features, powered by artificial intelligence
Spotify has a global market share of 31.7% in the music streaming industry, according to Statista. That places it well ahead of Tencent Music, which is in second place with a market share of just 14.4%. Every music streaming service offers a similar content catalog, so they can only differentiate themselves from the competition through pricing, technological features, and by delivering other content formats like podcasts.
Spotify invests heavily in the latter two differentiators. It uses artificial intelligence (AI) to power its recommendation engine, which ensures each user sees the content that is most relevant to them. But the company is also using AI to create unique features like AI DJ, which compiles personalized playlists and combines them with a software-generated voiceover for commentary during playback.
Then there is a newer feature called AI Playlist. Users can enter a text-based prompt referencing a place, a color, an activity, or even an emoji, and the AI engine will produce a unique list of songs to match. Features like AI DJ and AI Playlist are designed to keep users engaged with Spotify for longer periods of time, by giving them effortless access to content they genuinely enjoy.
On the content side, Spotify is already one of the world's biggest podcasting platforms. However, it's also making a splash in the audiobook space with over 375,000 titles in its library, and despite launching just two years ago, Spotify is already ranked second behind Amazon's Audible platform.
Image source: Getty Images.
Record revenue and surging profits
Spotify had a record 640 million monthly active users during the third quarter of 2024 (ended Sept. 30). That included 402 million free, advertising-supported users, and 252 million premium members who pay a monthly subscription. The premium figure came in 1 million higher than management's forecast of 251 million, which is important because those users account for 88% of Spotify's total revenue.
Total revenue came in at a record $4.2 billion during Q3, which was a 19% increase from the year-ago period. That was a strong result at face value, but it's even more impressive considering Spotify slashed its operating expenses by 7.8%. It included cuts in areas like marketing and research and development, which typically drive revenue and subscriber growth.
On the plus side, it led to a record result at the bottom line. Spotify generated $316 million in net income during the quarter, which was a whopping 361% increase from the year-ago period. Investors can expect more strength at the bottom line in the future, because CEO Daniel Ek says the company is set up for plenty of profitability expansion in the years to come.
Spotify stock might be expensive in the short term
Spotify is approaching a market capitalization of $100 billion, which is an incredible valuation milestone. But the stock might be a little expensive based on the traditional price-to-sales (P/S) valuation metric, which divides a company's market cap by its trailing-12-month revenue.
Spotify's P/S ratio is currently 5.8, which is 52% higher than its average of 3.8 since the company came public in 2018:
SPOT PS Ratio data by YCharts
Combined with the fact that Spotify stock is currently near a record high, it might not be the best time for investors to initiate a new position -- unless they are certain they can hold for at least the next eight years. Why eight years? Because the company has a goal to reach 1 billion active users in 2030, which could be followed by a whopping $100 billion in annual revenue two years after that.
From a mathematical perspective, $100 billion in annual revenue places Spotify stock at a forward P/S ratio of around 0.9. In other words, the stock would have to quadruple between now and the year 2032 just to trade in line with its average P/S ratio of 3.8, which is a fantastic potential return.
But it's important to take such long-term forecasts with a grain of salt, because nobody knows exactly what will transpire over that time frame. There could be significant changes to the music industry or even the competitive landscape. Plus, disruptive new technologies could emerge to supersede streaming entirely.
With that in mind, it might be best for investors to wait for a pullback in Spotify stock before they buy.
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John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Anthony Di Pizio has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Amazon, Spotify Technology, and Tencent. The Motley Fool has a disclosure policy.
