Share prices of Spotify Technology (SPOT +1.27%) are down 25% year to date. The stock has been under pressure in recent weeks over a boycott from a small group of artists that were challenging the accuracy of COVID-19-related comments made on Joe Rogan's podcast. In early February, the stock took a further dive following Spotify's fourth-quarter earnings results.
Management is taking to steps to address the artists' concerns, but the low expectations implied by the lower stock price don't reflect Spotify's future. The leading music streaming service still has plenty of opportunities to expand its reach around the world. Here's why the stock is still a good long-term investment.
Image source: Getty Images.
Lower valuation
Spotify ended the December quarter with 406 million monthly active users. While that represents an attractive 18% year-over-year growth rate, growth has been slowing. Monthly active users were growing around 30% per year before the pandemic through 2019.
The deceleration explains why the stock price is down 44% over the last year compared to the broader market's small gain. It's not surprising to see Spotify's growth gradually slow as the service reaches more users around the world, but the good news is that the market has already priced in the expectation for lower growth. On a price-to-sales basis, the share price is trading at its lowest valuation level since its direct listing in 2018.
SPOT PS Ratio data by YCharts
The market is undervaluing Spotify's leadership position in a growing market for paid music services.
Spotify is continuing to benefit from its ubiquitous service that is available across almost every device imaginable, from Peloton Interactive's exercise bikes to video game consoles. It got a head start on its competitors, notably Apple Music, which didn't get rolling until years after Spotify's launch in 2008. Even with new services emerging in recent years, Spotify continues to maintain its lead with a 32% share of the music streaming market, according to Statista. That's double the second-largest service, which is Apple.
Most young people primarily use their smartphones to listen to music. Spotify's massive reach translates to more songs getting shared and promoted over social media relative to competing music services. This network effect fuels more sign-ups, and Spotify still has a long way to go before reaching global saturation.
Geographic expansion
In Sweden, where the company was founded, about 45% of the population used a paid music streaming service in 2021, according to Midia. This is a higher proportion than in the U.S., which has a penetration rate of 38%. If 50% of the U.S. eventually used a paid music service, that would increase the addressable market for Spotify by up to 40 million, or 10% of Spotify's current monthly active users.
The penetration rate is even less in high-growth markets, such as Argentina, Mexico, Brazil, China, Russia, and India, where only 4% of the combined population use a paid music service. These countries seem to be following in the footsteps of the U.S., where only 9% of the population used a paid music service as recently as 2015.
It's these relatively low penetration rates around the world that explain why Spotify sees the potential to reach 1 billion users eventually. CEO Daniel Ek said on the fourth-quarter earnings call, "We are building a category-defining company, and this takes patience."
With a strong brand and relatively low penetration rates around the world, investors are likely undervaluing this leading subscription service right now. I believe now is a good time to buy the stock.
