Should You Sell Your Spotify Stock Now?

Did you hear the news? Recently, the world leader in audio streaming disappointed investors with a lackluster quarterly earnings report. Although they have already fallen by more than half this year, the shares of Spotify Technology (PLACE 1.98%) fell more than 11% overnight in response to a bottom line that strayed a little from positive territory.

Spotify shareholders have seen their investments fall 76.3% from their peak in early 2021. Is the company’s disappointing third-quarter report a sign that it’s finally time to cut and run?

Why Spotify Stock Dropped

Spotify is a relatively young company in a phase of strong growth. Investors are generally nervous about this and other growth companies these days. This is because soaring interest rates will increase their cost of capital and make positive profit margins much harder to achieve.

In the third quarter of 2021, Spotify reported strong operating profit which disappeared this year. During the third quarter of 2022, Spotify recorded an operating loss of $228 million which was even larger than the company’s operating loss in the second quarter of 2022.

Spotify is primarily a subscription business, but it generates advertising revenue from hundreds of millions of users who are not yet subscribers. As Investors Have Seen From Digital Advertising Giants Metaplatforms and Alphabetoverall digital advertising spending is contracting due to fears of a recession.

Why am I not selling

Profit margins that have moved in the wrong direction aren’t particularly troubling for some important reasons. First, Spotify’s huge user base continues to grow by leaps and bounds. Total monthly active users in the third quarter increased 20% year-over-year to 456 million and premium subscribers increased 13% year-on-year to 195 million.

Over the past two years, Spotify has managed to manage 46 price increases worldwide. In the short term, investors can expect a big bump in the still-important US market to help bring the company back to profitability. Spotify’s biggest competitor in the music streaming space, Apple, recently raised prices in the US by $1 for premium users. With a growing list of exclusive podcast content that its subscribers can’t access on Apple Music, Spotify will have no problem raising US subscription prices by $1 a month as well.

Image source: Getty Images.

why i will buy more

When Spotify went public in 2018, it told investors to expect a gross profit margin of around 30% to 35% of total revenue. The company came close to that goal in 2021, but heavy investment in its future has taken it away this year.

SPOT Gross Profit Margin Chart

SPOT Gross Profit Margin Data by YCharts

Big changes like getting into podcasting and audiobooks hurt profitability this year, but that’s most likely temporary. Music streaming is typically a low-margin business as artists expect to be paid each time their content is heard. Podcasters, on the other hand, happily distribute their content for free because they can fill that content with lucrative advertisements. For this reason, Spotify estimates that its podcasting business has a gross margin potential of 40% to 50%.

It’s only been three years since Spotify started integrating podcasts into what was just a music streaming app. It’s already the #1 platform used by podcast listeners in the US and other developed markets. Its competitors haven’t even begun to enter the lucrative space, which means Spotify’s already excellent customer retention rate will most likely grow stronger.

Spotify’s highly successful podcast business is proving its platform to be a powerful machine capable of taking on new verticals. Spotify’s next vertical goal is an audiobook delivery market that it estimates to be around $70 billion a year. The new integration is currently reducing profitability, but Spotify believes its audiobook business can maintain a gross margin above 40% once it has a chance to mature.

If Spotify were still just a music streaming company, the larger-than-expected loss reported in the third quarter would be a reason to sell and/or avoid the stock altogether. However, a well-executed investment in podcasting and a more recent push into audiobooks put Spotify ahead of its closest competitors.

That won’t happen in 2022, but higher margins on podcasts and audiobooks will help this relatively well-run business post a reliable profit. Adding a few beat-up Spotify stocks to an already well-diversified portfolio seems like a sensible idea right now.

Suzanne Frey, an executive at Alphabet, is a board member of The Motley Fool. Randi Zuckerberg, former director of market development and spokesperson for Facebook and sister of Meta Platforms CEO Mark Zuckerberg, is a board member of The Motley Fool. Cory Renauer holds positions in Spotify Technology. The Motley Fool owns and recommends Alphabet (A shares), Alphabet (C shares), Apple, Meta Platforms, Inc. and Spotify Technology. The Motley Fool recommends the following options: long calls $120 in March 2023 on Apple and short calls $130 in March 2023 on Apple. The Motley Fool has a disclosure policy.

Comments are closed.