Buying and holding great growth stocks over the long term can be one of the best ways to generate market-crushing returns. But finding companies that can grow for a sustained period of time can be difficult.
In a market that might be less friendly to growth stocks than it was during the past decade, investors need to be discerning with their picks today. And I think Spotify Technology (SPOT 0.00%) and Topgolf Callaway Brands (MODG -6.73%) have what it takes to be great growth stocks for the next decade.
Spotify can own your ears
The Spotify you see today is not the Spotify we will see a decade from now. The company currently generates a vast majority of its revenue from premium subscriptions and loses over $0.50 for every dollar in revenue it has from the podcast business. But those dynamics will change in time.
On the music side, Spotify's profitability is limited because it deals with four major record labels as suppliers. Any one of those labels leaving could endanger the business, which is why the company's gross margins have hovered in the mid-20% range for years. However, a shift to add "marketplace" (or advertising revenue from artists and labels) has increased music gross margins to 28% in 2021, and management thinks it can push that to 35% over the long term. But there's a cap on music's growth as the business exists today.
Podcasts aren't nearly as limited from a margin perspective and are likely just getting started. Spotify doesn't break out podcast revenue and margins directly, but an investor presentation in June said that 2021 podcast gross margins were negative 57%. That's incredibly low and shows how early Spotify is in building out its podcast business.
Look at this as an investment in content, creation tools, and advertising infrastructure to eventually generate positive margins -- which management thinks can reach 40% to 50%. The good news is that if Spotify figures out the monetization of podcasting, it will have a nearly unlimited supply of content available.
Tying all of this together would be an advertising business. If Spotify can match listeners with advertisers in a targeted way, it could create a valuable advertising model similar to Facebook or YouTube, but for your ears. Ad-supported revenue was up 31% in the second quarter, but gross margin was only 1.1%. If Spotify can build scale in advertising, this stock could be a growth machine.
Investors seem to pick apart something about Spotify's results every quarter. Still, the company grew revenue 23% last quarter and continues to expand its offerings for listeners and to add monthly users. That's an incredible place to be, and if Spotify can build an advertising business that helps creators monetize podcasts, it could be a win for creators, listeners, and the company.
Topgolf Callaway is reimagining golf
Golf historically hasn't been a great space for investing, but I think Topgolf Callaway has a strategy that can grow for decades. Its legacy golf equipment business is excellent, with revenue of $1.43 billion in the first six months of the year and an operating margin of 17.5%. But it's Topgolf that will ultimately drive the company's growth.
In the first half of 2022, Topgolf's revenue was $725.7 million, up from $418.1 million a year ago, and operating profit was $50.7 million. And this is just scratching the surface of the company's potential.
There were 70 Topgolf venues at the end of 2021, and management expects 81 to be open by the end of this year. It is targeting revenue growth of over 18% from 2021 to 2025.
Not only are Topgolf's financials impressive, with an expected 40% to 50% rate of cash return on the cash invested in the sites, but the company is also building technology that it's selling to other sites and consumers. For example, Toptracer is a popular technology that traces the ball flight of a shot, and Topgolf media is building games for virtual reality and digital content for venues.
Coming out of the pandemic, Topgolf Callaway has a great strategy to keep its legacy business relevant and profitable while using cash to fund growth at Topgolf. As long as people are looking for entertainment and event spaces, Topgolf will be an outstanding growth business, and that's why I like this stock.
Not all growth looks the same
Growth doesn't need to come from tech stocks and doesn't have to be at small companies. Spotify is established but continues to grow into a big market. Topgolf Callaway is a consumer goods company building a new entertainment concept.
What they have in common is revenue growth and positive cash generation from operations. In today's market, sustainability is a must-have for growth stocks.
MODG revenue (TTM). Data by YCharts. TTM = trailing 12 months.
I think both companies can be huge winners over the next decade, and that's why I'm buying and holding these stocks for the long term.
