Is Spotify Stock a Buy Now?

Spotify's (SPOT 1.13%) stock plunged 17% to its lowest levels since May 2020 after the streaming music giant posted its fourth-quarter earnings.

Spotify's revenue rose 24% year over year to 2.69 billion euros ($3.08 billion), which topped analysts' estimates by 34 million euros. It narrowed its net loss from 125 million euros to 39 million euros ($45 million), or 0.21 euros ($0.24) per share -- which also comfortably beat expectations by 0.15 euros.

Those headline numbers looked solid, but Spotify's monthly active user (MAU) and premium subscriber forecasts slightly missed analysts' expectations. Did the market overreact to that soft guidance and create a fresh opportunity to invest in the world's largest premium streaming music platform?

Image source: Getty Images.

Why did Spotify's stock stumble?

Spotify's total MAUs grew 18% year over year to 406 million during the fourth quarter. Its paid premium subscribers grew 16% to 180 million, while its ad-supported MAUs increased 19% to 236 million.

All three growth rates have decelerated over the past year, but its growth in MAUs and premium subscribers still matched its previous forecasts.

Data source: Spotify. YOY = Year-over-year. MAU = monthly active user.

In the first quarter of 2022, Spotify expects its total MAUs to grow 17% year over year to 418 million, and for its premium subscribers to rise 16% to 183 million. However, that forecast missed analysts' expectations for 422 million MAUs and 185.3 million premium subscribers. It expects its total revenue to rise 21% to 2.6 billion euros ($3 billion), which matches analysts' expectations.

That miss was minor, but three other issues likely exacerbated Spotify's sell-off. First, rising interest rates are causing investors to closely scrutinize growth stocks and quickly dump the ones that don't hit grand slams. Spotify's ongoing losses make it even less appealing.

Second, Spotify is still grappling with an exodus of artists -- including Neil Young, Joni Mitchell, Nils Lofgren, India Arie, David Crosby, Stephen Stills, and Graham Nash -- in response to Joe Rogan's controversial comments about COVID-19 vaccines on his podcast. Spotify is trying to remain neutral by posting content advisory warnings for podcasts that discuss vaccines, but this escalating crisis could impact its growth in the first quarter.

Lastly, Spotify's gross margins are slipping. Its gross margin of 26.5% in the fourth quarter stayed flat from the prior-year quarter, but dipped sequentially from 26.7% in the third quarter. It expects that contraction to continue with a gross margin of 25% in the first quarter of 2022 -- and it said it would no longer provide any gross margin guidance for the full year.

That compression and obfuscation suggests Spotify could lose its pricing power as it ramps up its investments in new content. That's a red flag, since Spotify's big tech competitors -- including Apple Music, Amazon Music, and Alphabet's YouTube Music -- can all afford to take losses on their competing platforms to gain more users.

On the bright side, Spotify's net loss narrowed from 581 million euros ($666 million) in 2020 to just 34 million euros ($39 million) in 2021 -- and analysts expect it to generate a net profit of 60 million euros ($69 million) in 2022. We should take that forecast with a grain of salt, but it suggests that Spotify's operating margins could expand and offset its gross margin compression as it dials back its marketing spending and increases its dependence on higher-margin podcasts.

Spotify also reiterated its long-term guidance for reaching a billion users and expanding its gross margin to 35%-40% -- but it didn't set any concrete dates for those ambitious goals.

Spotify's stock looks cheap, but it could get cheaper

Spotify grew its revenue 23% in 2021, and analysts expect 20% growth in 2022. Based on that forecast and its current price of $160 per share, Spotify trades at just 2.3 times its 2022 revenue.

Netflix (NFLX 1.74%), which also stumbled after its latest earnings report, trades at 5.4 times its 2022 revenue, even though it's expected to grow its top line by just 12% for the full year. But Netflix is also firmly profitable, which arguably makes it a more stable investment than Spotify.

If you believe Spotify is still on track to hit a billion listeners in the future, this pullback might represent a good long-term buying opportunity.

However, I believe the near-term headwinds -- including its decelerating user growth, its unresolved issues with Joe Rogan, and its declining margins -- are still too daunting to ignore in this challenging market for growth stocks. Therefore, Spotify looks cheap, but I think it could get a lot cheaper before investors consider it to be a good turnaround play.