Spotify's (SPOT 1.31%) stock price tumbled after the streaming music giant posted its fourth-quarter earnings this week. Its revenue rose 17% year over year to 2.17 billion euros ($2.61 billion), which narrowly beat estimates by 20 million euros. Its net loss narrowed from 1.14 euros per share to 0.66 euros ($0.79), but still missed expectations by 0.11 euros per share.
Spotify expects its revenue to rise 14%-19% in fiscal 2021, but analysts were anticipating 21% growth. That conservative guidance, along with its bottom-line miss, seemingly spooked the bulls.
Despite those near-term challenges, I believe investors should stick with Spotify, for five simple reasons.
1. Its audience is still growing
Spotify's monthly active users (MAUs) rose 27% year over year to 345 million during the fourth quarter, hitting the top end of its prior guidance for 340-345 million MAUs.
Its total number of premium subscribers increased 24% year over year to 155 million, which beat its own forecast for 150-154 million subscribers. Its number of ad-supported MAUs grew 30% to 199 million.
Spotify expects its MAUs to rise another 24%-27% year over year in the first quarter of 2021, and for its premium subscribers to grow 19%-22%.
For the full year, it expects its MAUs to increased 18%-24%, and for its premium subscribers to grow 11%-19%. Those stable growth rates indicate Spotify isn't losing listeners to big challengers like Apple (AAPL -2.46%) Music and Amazon (AMZN 0.19%) Music.
2. Its ad business is recovering
Spotify's MAUs and subscribers increased throughout the COVID-19 pandemic, but the crisis throttled its growth in ad revenue throughout most of 2020.
That crisis seemingly ended in the fourth quarter, as its ad revenue rose 29% year over year to 281 million euros ($338 million) and marked the segment's strongest growth in three quarters.
That growth was led by its podcast and ad studio platforms, which both more than doubled their ad revenues year over year. During the conference call, CEO Daniel Ek noted Spotify was still "putting more resources" into its ad platforms, and that those investments had "accelerated" their growth.
3. Its gross margin is stable
Spotify posted a gross margin of 26.5% in the fourth quarter -- up from 24.8% in the third quarter and 25.6% in the prior year quarter -- which surpassed its previous guidance of 24.2%-26.2%. That expansion can partly be attributed to the recovery of its advertising business.
During the call, CFO Paul Vogel warned that higher investments, especially on podcasts, could weigh down the company's gross margins throughout 2021, but he remained "optimistic" that Spotify's revenue growth would eventually outpace its investments over the long term.
4. Rebounding revenue from premium subscribers
The average revenue per user (ARPU) of Spotify's subscription business dipped 8% year over year during the fourth quarter due to an unfavorable mix of foreign exchange headwinds, lower-revenue streams, and cheaper subscription fees in certain regions.
However, Spotify still expects its premium ARPU to improve sequentially throughout 2021, presumably as it raises its prices in certain markets and reduces the availability of lower-value family plans.
Spotify's churn rate for premium users also declined year over year in the fourth quarter, and it expects that decline to continue throughout 2021. Spotify's belief that it can continue raising its prices without sparking more cancellations indicates it still enjoys plenty of pricing power against its big tech rivals.
5. Narrowing losses and a reasonable valuation
Spotify still isn't profitable, and its business remains squeezed between high content licensing costs and infrastructure expenses. However, its net loss narrowed year over year in the fourth quarter, from 209 million euros to 125 million euros ($150 million).
Spotify won't turn a profit anytime soon, but it trades at about six times this year's sales, which is a reasonable price-to-sales ratio for a leader of a growing market. China's Tencent Music (TME 0.00%), which Spotify owns a stake in, trades at 10 times this year's sales.
The bottom line
Spotify's stock could remain volatile for the foreseeable future, but its audience is still expanding as it leads the global streaming music market. Its fourth-quarter earnings report was certainly disappointing, but it doesn't mean its high-growth days are over.