Establishing an Individual Retirement Account (IRA) and contributing the annual maximum from a young age offers one of the surest ways to ensure a comfortable retirement.
For example, a 22-year-old who contributes the maximum allowable $6,000 every year into a Roth IRA until age 60, and earns an average annual return of 9% (roughly the long-term stock market average) will have a tax-free nest egg worth about $1.7 million. That's the power of tax-free compounding one can get from an IRA. And considering that the maximum allowable contribution occasionally increases, the future value of that nest egg has the potential to be even higher.
We know that establishing an IRA is important, but what should you invest in? Most financial advisors would first suggest you focus on picking a well-regarded index fund to get the investing diversification you need to ensure long-term performance. But if you are set on incorporating individual stocks into your IRA as well, there are three great stocks you might want to consider: Amazon.com (AMZN +2.05%), Netflix (NFLX +0.96%), and Spotify (SPOT 2.23%).
What makes them great? Each is a high-quality business that has decades of growth ahead, significant competitive advantages, founder-CEOs who own billions of dollars worth of company stock, and a stock price that reflects modest expectations relative to the company's long-term potential. Let's take a closer look at each.
Image source: Amazon.
1. Amazon: Active in several areas with enormous opportunity
Amazon is the perfect stock for an IRA. While it is one of the largest companies in the world, it still has a long runway. Its retail business, which includes everything except Amazon Web Services (AWS) and the "Other" net sales line, generated $231 billion of net sales last year. That's only 0.9% of the estimated $25 trillion of global retail sales. Even considering an estimated $300 billion of gross merchandise volume (GMV), which the company does not disclose but includes everything sold through Amazon whether by Amazon itself or by third-party sellers, Amazon's share of global retail sales appears less than 1.3%. That leaves a lot of addressable market still available to capture.
Then consider Amazon's cloud business, Amazon Web Services, which had net sales of almost $10 billion last quarter or a $40 billion annual run rate. Andy Jassy, the CEO of AWS, thinks the segment is going after a $3.7 trillion global IT market, 97% of which is still on-premise, or not yet in the cloud. That represents enormous opportunity ahead.
Amazon also has a rapidly growing and high-margin ad business, which is the bulk of the $14 billion "Other" net sales line that grew 39% last year. But the best part is Amazon doesn't just sit back and grow its existing businesses -- it invents new ones out of thin air and has done so with remarkable success over its history. Count on one or more big new businesses emerging over the next decade or two to help the stock pad your IRA value.
2. Netflix: A solid plan to grow subscribers and profit from them
Too many investors look at Netflix's historical stock chart and assume they missed the opportunity to buy it at a good price. Nothing could be further from the truth. Netflix has 167 million global subscribers, but there are projected to be at least 1.6 billion global internet-connected households a couple of decades from today. And most households have shown a willingness to pay for video entertainment. At the peak of pay-TV in 2012, before people began seriously cutting the cord in favor of streaming, 87% of U.S. households paid for television. And consider that the usual cable package costs households over $100 per month -- several multiples more than Netflix's $12.99 per month for its standard plan. There's no reason the vast majority of those 1.6 billion or more global households wouldn't subscribe to Netflix over the next several decades, considering it is rapidly investing in new content that appeals to audiences around the world.
Netflix is likely to be much more profitable in the future when it has several hundred million global subscribers. With each passing year it invests in new content, it is building up a permanent library for new subscribers to explore that is already paid for. That means its content costs on a per-subscriber basis will almost certainly fall over the long term, even if total content costs continue to rise. Couple that with gradually rising average revenue per user (through periodic price increases) and you have the recipe for huge long-term improvements in profitability.
Image source: Getty Images.
3. Spotify: A superior product that's becoming indispensable
Spotify is the world's largest audio streaming business with 271 million monthly active users (MAUs), including 124 million premium subscribers and 152 million ad-supported MAUs. These figures grew by an impressive 31%, 29%, and 32%, respectively, in the company's fourth quarter. Like Amazon and Netflix, Spotify has captured only a small fraction of its total long-term addressable market. There are over 3 billion global smartphones in Spotify's territories or future territories that could represent future users. So Spotify has captured less than 9% of its global opportunity today. And smartphone adoption continues to grow around the world.
Spotify is underestimated by investors because people focus on its reliance on the major music labels, the fact that its music royalties are a variable cost that increases as revenue increases (as opposed to a fixed cost that stays flat as revenues increase), and the existence of competing music streaming platforms from the big tech companies.
But the tables are slowly turning: Spotify is becoming less reliant on the big-name music labels as it expands into non-music content like podcasting, while the music labels are becoming more reliant on Spotify since streaming is their only source of recorded music revenue that's growing. That means Spotify's negotiating position should only improve over time.
And while music royalties will remain a variable cost, the podcasting content it increasingly owns coupled with its game-changing podcasting ad technology is likely to create more Netflix-like fixed cost leverage that the company has lacked up to this point.
Finally, Spotify has a superior product as evidenced by the far greater number of users and paying subscribers, and it has much higher listener engagement. Management has said its user engagement is twice that of Apple Music's listeners and three times that of Amazon Music's listeners. Stock investors should consider Spotify for their IRAs, hang on for decades, and reap the rewards.
