Legendary investor Peter Lynch famously told investors to invest in "what they know." But that oft-repeated quote doesn't mean to simply invest in a company because you like its product or service. Instead, it means to use your own knowledge to spot promising brands, then to do your own homework to see if they are worthy investments.
AT&T (T 0.54%) and Spotify (SPOT 5.88%) are two such brands that many Americans use on a daily basis. AT&T owns one of the top wireless services in America, and Spotify is the world's most popular subscription-based streaming music service. Yet these two stocks appeal to different types of investors: AT&T is usually owned for its stability and high dividends, while Spotify generates stronger growth from the streaming music market.
But over the past 12 months, AT&T's stock dipped about 8% while Spotify's stock nearly doubled. Will Spotify maintain that momentum, or will AT&T finally have its day in the sun?
Why did the bulls ignore AT&T?
AT&T has faced several headwinds over the past year. Its wireless growth remained sluggish, due to market saturation, postponed upgrades ahead of new 5G devices, COVID-19 shutdowns of retailers, and intense competition from Verizon and T-Mobile. AT&T's pay TV business continued to lose subscribers to stand-alone streaming services, and the pandemic forced its newly acquired Time Warner unit to postpone its production and releases of new movies and TV shows.
AT&T's streaming and integration plans for Warner's properties remain fragmented, and it's still shouldering significant debt from its acquisitions of DirecTV, AWS-3 spectrum licenses, and Time Warner. Those challenges, along with a clash with an activist investor and a CEO change, raised tough questions about its long-term growth.
AT&T's revenue rose 6% last year, thanks to a boost from Time Warner, and its adjusted EPS grew 1%. It didn't offer any guidance for 2020 due to COVID-19, but analysts expect its revenue and earnings to decline 6% and 11%, respectively. Those dim forecasts suggest its core businesses will struggle as the temporary suspension of its buybacks eliminates its ability to "buy" additional earnings growth.
Why did the bulls embrace Spotify?
Spotify faced plenty of skepticism when it went public two years ago, since it was paying high music royalties, wasn't profitable, and faced intense competition from well-funded rivals like Apple Music.
Yet Spotify continued to grow its monthly active users (MAUs), paid subscribers, and total revenue at double-digit rates. At the end of 2019, its MAUs rose 31% annually to 271 million, its premium subscribers grew 29% to 124 million, and its revenue increased 29%.
That momentum continued in the first quarter, as its 31% annual growth in both MAUs and premium subscribers lifted its total revenue 22%. Those growth rates indicated it wasn't losing ground to Apple Music and other rivals, and that there was still room for multiple music streaming platforms to grow.
Furthermore, Spotify's operating margins expanded sequentially and annually last quarter as tighter cost controls offset its higher licensing fees. Spotify remains unprofitable, but its losses are stabilizing and it has zero debt.
For 2020, Spotify expects its total MAUs to grow 21%-28%, its premium subscriber base to expand 15%-23%, and its revenue to rise 13%-19%.
But which stock is the better buy?
AT&T's core strength is its dividend, which it's raised annually for 36 straight years. That makes it a Dividend Aristocrat of the S&P 500, or a member of the index that has raised its payout for at least 25 consecutive years. It pays a forward yield of nearly 7%, and it spent just 55% of its free cash flow on its dividend over the past 12 months.
Therefore, AT&T remains a reliable core investment for long-term investors, since its total returns (which include its reinvested dividends) should still outpace inflation. The stock also trades at just nine times forward earnings.
Spotify doesn't pay a dividend, it isn't profitable, and its stock isn't particularly cheap at six times this year's revenue. But it's still a better buy than AT&T, for four simple reasons: It generates stronger sales growth, has a cleaner balance sheet, operates a simpler business model, and is better insulated from the COVID-19 crisis and other macro headwinds.