Up Almost 100% This Year, Is It Time to Sell Spotify?

investors in spotify (spot 0.68%) I’ve been riding roller coasters for the last few years. The stock rose more than 100% in late 2020 and early 2021, but plummeted during the 2022 bear market as it failed to contain costs and achieve profitability. The stock has fallen more than 80% from its all-time high in less than two years.

Meanwhile, 2023 is going to be a pretty good year for shareholders, with the stock up 85% year-to-date at the time of writing. Music and audio streaming platform numbers, likely due to the overall bull market, management’s cost-cutting measures, and impressive growth in the first quarter.

If you own Spotify, you’re probably debating whether you should sell your stock after this monster bull market. Let’s see if now is the right time to let go of stocks.

Steady growth and path to profitability

General market volatility aside, Spotify’s stock price has surged this year as the company’s business is starting to get healthier.

Monthly Active Users (MAU) in Q1 reached 515 million, up 22% year-over-year, and 26 million new users were added to the platform in the first three months of 2023. Revenue growth slowed slightly in US dollar terms. Despite the impact of foreign exchange translation (Spotify operates in all major markets outside of China) and a downturn in the advertising market, it still generated $12.6 billion in revenue over the last 12 months, up from the last five. Increased by more than 100% year-on-year.

SPOT Revenue (TTM) Data by YCharts

Users and revenue have never been an issue for Spotify. It’s profitability (or lack of profitability) that has made investors pessimistic about this business in recent years.

Last quarter, Spotify’s operating margin was negative 5%, which is clearly not sustainable over the long term. Management has addressed this profitability problem by de-focusing on high-priced podcast deals and reducing headcount.

The company laid off 600 employees in early 2023 and laid off another 200 this week. These job cuts haven’t been reflected on the income statement yet, but should lead to operating leverage as long as Spotify can continue to grow sales.

how the rating changed

But where will Spotify’s profit margin land once the business matures? Management thinks around 10%, which they hope to reach within the next three to five years. Annual profit equates to him $1.26 billion, compared to $12.6 billion in final revenue.

Earlier this year, when Spotify had a market capitalization of just $15 billion, it could be argued that the stock was cheap even if it met its 10% profit margin target, even if earnings didn’t grow significantly from current levels. did it. With a market capitalization of $15 billion and annual earnings of $1.26 billion, it trades at just 12 times earnings, well below the market average.

Spotify is currently valued at $29 billion, and even if it hits its 10% profit margin target, it’s going to be more than 25 times more than the market average. That makes valuation calculations much more difficult than they were earlier this year.

Why (yet) there is no reason to sell

I don’t think Spotify is an outstanding buy at this level, but there’s no reason for shareholders to prune the flowers and sell this winner early. The company looks poised to grow revenue significantly over the next few years with continued music streaming subscriptions, podcast advertising pricing power, and steady user growth around the world.

If Spotify doubles its revenue over the next five years, it could hit $25 billion in annual revenue. At a 10% profit margin, he equates to $2.5 billion in annual revenue for the fast-growing company. That scenario isn’t guaranteed, but even after its explosive performance in early 2023, it’s likely that Spotify’s stock will be even higher five years from now.

A big mistake many investors make is selling the winners early. Just because you feel Spotify is a safe choice in 2023, don’t make that mistake.