Spotify (SPOT -1.03%), the world's largest audio streamer, released its third-quarter results before the market opened on Wednesday. According to management, the company grew its users, revenue, and profits better than expected for the period. This is likely why investors were excited about the results, sending Spotify stock up over 5% in Wednesday's trading session as of this writing. 

Here's what these Q3 results mean for Spotify's stock going forward. 

A person smiling while riding the bus and listening to music through headphones.

Image source: Getty Images.

Third-quarter results

In the third quarter, Spotify's monthly active users (MAUs) grew 19% year over year to 381 million. Premium subscribers, who are users that pay a monthly subscription for ad-free music listening, also grew 19% year over year to 172 million. There are now 220 million ad-supported and 172 million premium subscribers on the Spotify platform. These numbers helped premium revenue grow 22% year over year to $2.5 billion.

Premium revenue was helped by the growth in average revenue per user (ARPU), which grew 4% year over year to $5.04. This growth in paying subscribers is an important development for Spotify because it has seen a decrease in ARPU over the last few years as it tried to grow as fast as possible around the world. Recently, it has started to raise prices in more of its mature markets, like Europe and the United States. So it's a good sign the company can raise prices while still growing in terms of premium subscribers.

For the full year, Spotify reiterated its guidance for 400 million to 407 million total MAUs and 177 million to 181 million premium subscribers. The company is still giving a wide range for guidance targets due to the uncertainties with the pandemic, which management said hurt growth in Q2 in international markets. But if it can hit this range, revenue growth should fall in line too. 

Advertising should accelerate growth

Spotify's premium music business is chugging along just fine, but the main drivers of this company right now are advertising and podcasts. In Q3, advertising revenue grew 75% year over year to $375 million and is on track to do well north of $1 billion in revenue this year. Spotify has recently ramped up its advertising ambitions with its push into podcasts, which management has said will be mostly monetized through advertising.

With its acquisitions of top studios like Parcast and The Ringer, licensing of top shows like The Joe Rogan Experience, and the purchase of two top podcast distributors Anchor and Megaphone, Spotify has greatly increased the number of podcasts it owns or has a relationship with. To make money off of this, Spotify is rapidly growing its Spotify Audience Network (SPAN). SPAN is an advertising network similar to YouTube (but for audio) where advertisers and creators never meet but have Spotify act as an intermediary that connects audio ads to relevant listeners. Right now, this is still small relative to Spotify's overall business, but the company has a long growth runway to convince both advertisers and podcast hosts to join SPAN around the globe.

Valuation is still reasonable

Unlike most high-growth tech companies, Spotify stock trades at a fair valuation. With a market cap of $51 billion and $10.8 billion in trailing twelve-month revenue, the stock has a trailing price-to-sales (P/S) ratio of 4.7. Spotify has low gross margins due to the licensing deals it has signed with music labels, which is why the gross margin was only 26.7% last quarter. 

However, Spotify's gross margin potential is understated because of all the investments it is making into podcasts and advertising, which get included under the cost of revenue in its advertising segment. This segment only had 10.5% gross margins in Q3, but management thinks over the next few years it can greatly expand while also growing revenue at a high rate, helping Spotify expand its consolidated gross margins and cash-generation potential. 

With founder Daniel Ek at the helm, Spotify looks to be doing great at the moment and has a long runway to grow as the world's leading audio platform. Even with the 5% pop after these Q3 results, Spotify still looks like a great stock to buy and hold for the long term