Spotify Technology's (SPOT -7.28%) key performance metrics surpassed management's guidance in the first quarter. Monthly active users grew 19% year over year to 422 million, which led to a 24% increase in revenue.
Yet the stock plunged to a new 52-week low of $95.22 following its first-quarter earnings report. The shares have recovered somewhat since and currently trade at $109.
Is it time to buy?
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The stock's low valuation could lead to big returns
It's difficult to predict short-term price movements. But just focusing on the business performance and valuation, the stock could be a great investment at these levels.
A year ago, Spotify shares traded at a price-to-sales (P/S) ratio of around 5 but now trade at just 1.8 times sales. That translates to a modest price-to-earnings (P/E) ratio of 18 for a business that can generate an average profit margin of 10%. For what it's worth, the average stock in the S&P 500 index trades at a P/S multiple of 2.66 and a P/E of 21.
Spotify's deceleration in growth of monthly active users through 2021 likely contributed to the stock's collapse. It seems the market thought all streaming stocks were facing the same headwinds, especially after Netflix's string of disappointing quarters.
However, for Spotify, the market is missing the year-over-year acceleration in revenue growth. In the year-ago quarter, monthly active users grew 24%, while revenue increased by 16%. In the most recent quarter, Spotify reported user growth of 19%, with revenue up 24% year over year.
Investors can credit Spotify's investments in podcasts and higher ad-supported revenue, which grew 31% in the first quarter. Users engaged with podcast content continue to outpace overall user growth across Spotify. This is helping the company improve its average revenue per user, which increased by 3% year over year on a constant-currency basis.
There is growing demand for digital audio
Spotify is not suffering from the subscription fatigue and competitive issues that are hurting Netflix right now. The market doesn't seem to understand this yet, and this is providing a great buying opportunity.
Investors may want to see better profitability from the streaming leader. For all that growth on the top line, the company reported a $6 million loss before interest and taxes. Management is guiding for an even bigger operating loss in the second quarter as it continues to invest for long-term growth.
Most importantly, Spotify is free cash flow positive. This metric reflects the actual amount of cash the company has generated from operations and is a better indicator of Spotify's profitability. Over the last four quarters, the company reported $307 million in free cash flow against $11.8 billion in trailing-12-month revenue. This margin has been gradually improving over the last five years.
SPOT Free Cash Flow data by YCharts.
Investors should also note that Spotify has a tailwind of strong industry growth in music streaming. In 2021, streaming revenue surpassed total music industry revenue in each year from 2009 and 2016.
As the market expands, Spotify continues to maintain a commanding lead, with a 31% market share in the global music streaming market, according to MIDiA research. That is more than double Apple Music, with a 15% share of this $16.9 billion market.
With the stock selling for a cheaper valuation, it's only a matter of time before the sentiment changes and the stock begins moving higher. It's difficult to call bottoms, but if you look at Spotify's strong revenue growth, free cash flow, and growing demand for digital audio, you'll see that the stock should be a great investment at its current share price.
