If you're looking for a business that dominates its market, is growing like a weed, has a huge growth runway in the decades ahead, has multiple levers to improve margins over time, and has low investor expectations, look no further than Spotify (SPOT 1.80%).
Here's why Spotify is my top stock to buy in November.
Long-term market opportunity
Spotify dominates the subscription audio streaming business globally, ending September with 320 million monthly active users (MAUs), including 144 million paid Premium subscribers. Both of those figures grew a rapid 29% and 27%, respectively, compared to the year-ago quarter.
That's a huge user base already, but there's still a huge opportunity in the years ahead. Whether we look at the more than 3 billion payment-enabled smartphones in Spotify's markets, the 6.4 billion and growing global population outside of China (where Spotify doesn't compete), the precedent of other global digital platforms like Facebook and Alphabet's Google that have multibillion-strong user bases, it's not hard to imagine Spotify eventually having total MAUs over 1 billion.
In fact, on the company's third-quarter conference call, co-founder and CEO Daniel Ek said, "Even though we have 320 million monthly active users, we still think that there are billions more to go after in this ecosystem."
But it's not just further MAU and paying subscriber growth that's to come; Spotify also looks likely to make more revenue per user and per subscriber in the future.
In its Premium segment, the company plans to raise prices in its more mature markets where it sees strong subscriber engagement. It just raised prices on its Family plan in seven international markets, and more selective price increases are to come.
In the Ad-Supported segment, Spotify is growing its supply of owned and exclusive (O&E) podcast content. For example, it acquired Bill Simmons' pop culture website and podcast network, called The Ringer, earlier this year, and signed Joe Rogan's hit podcast The Joe Rogan Experience to a multiyear exclusive deal starting in December.
Importantly, Spotify owns the advertising airtime on these O&E podcasts. As MAUs and O&E podcast listening continues to grow, advertisers should continue to flock to Spotify. In fact, the number of advertisers just doubled last quarter versus the prior quarter.
Long-term profit upside
The big quibble investors have long had with Spotify is its low profit margins, driven by the high royalty rates it's required to pay the music labels and other rights holders. That makes it more difficult for Spotify to get a lot more profitable in music streaming.
But investors should be paying attention to the numerous levers Spotify has to pull to improve its margins. Consider the "two-sided marketplace," which essentially charges artists and labels for more exposure to their fans. One feature of the marketplace is called sponsored recommendations, which allow artists to essentially advertise their works to the subset of users that Spotify knows will like them. Ek has said in the past this has "software type margins," which are very high.
A lot more is in the works. On Spotify's third-quarter conference call, Ek discussed the company's three-part strategy of helping artists grow, engage, and monetize their fan bases better. The company is building tools and features to help artists do these things in relation to recorded music, live events, virtual events, and artist merchandise. As Spotify builds out these services, it should become an even more important platform to the artist community, which should drive more profits its way.
Additionally, Spotify's growing podcast advertising on its O&E podcasts is likely to significantly boost profits in its Ad-Supported segment. Generating more ad revenue per podcast should be very lucrative over time.
Low investor expectations
None of this would matter if investor expectations were high and already reflected these great things. But investor expectations for Spotify are low.
One example is the fact that Spotify is not considered a business with pricing power. That's because streaming music has long been viewed by investors as an undifferentiated commodity offered by several big technology players, including Apple, Amazon, Alphabet, Sirius XM's Pandora, and others.
But Spotify's management believes it most certainly has pricing power. For one thing, the company hasn't raised prices in most of its markets since it launched. The $9.99 per month for an individual Premium subscription in the U.S. has been that price since the service launched in 2011.
Additionally, the price increases Spotify has implemented in certain test markets around the world have had "no [negative] impact whatsoever" on subscriber retention. So betting on the company having pricing power over time, despite investor skepticism and low expectations, is a strong bet to make.
Another sign that expectations may be low is the fact that Spotify shares have tanked 19% since prior to its earnings report last week. While short-term traders may have found reasons for disappointment, long-term investors should consider the company's big revenue and profit opportunities more promising than ever. That's why Spotify is my top stock to buy in November.