Despite the Nasdaq Composite (^IXIC 2.02%) index jumping 23% so far in 2023, the technology sector is still finding its feet after a brutal sell-off last year.
Many individual tech stocks are still down substantially from their all-time highs, and the companies will have to lift themselves out of this valuation slump by delivering a strong operating performance. That includes steady growth and creating a pathway to profitability.
Music streaming giant Spotify (SPOT 0.20%) is proving it can accomplish both of those things. Its stock soared 10% after the release of its financial results for the third quarter, and its shares have now more than doubled in 2023 -- yet remain 53% below its all-time high, set in 2021.
Below, I'll explain why Spotify stock is likely to recover even more ground in the coming months, and why investors should go along for the ride.
Image source: Getty Images.
Consumers continue flocking to the Spotify platform
The music streaming business is tough. All of the major platforms -- including Spotify, Apple Music, and Amazon Music -- offer practically identical content, so they have limited ways to compete with one another. Pricing is one lever they can pull (to an extent, because it's partly regulated by the music industry), and they can also invest heavily in technology to improve the user experience.
Spotify is a specialist in the latter area, with arguably the most feature-rich platform in the industry. Earlier this year, the company launched a new artificial intelligence (AI)-powered feature called AI DJ. While almost all streaming platforms now use AI to curate playlists for listeners based on their individual preferences, AI DJ takes that experience to a new level. It plays a track list much like a party DJ would, complete with commentary using a software-generated voiceover.
In September, Spotify elevated the AI DJ experience yet again with a new feature called daylist. It's a living playlist that updates several times throughout the day using data it has collected on each listener. Spotify knows different times of day bring about different emotions, and that calls for a more fluid experience from the platform. As the AI delivers better recommendations over time, daylist has the potential to substantially boost engagement.
While that's just a sample of Spotify's ever-expanding feature set, it's clear the platform's commitment to innovation is attracting new customers. It ended Q3 with 574 million monthly active users, a remarkable increase of 118 million (or 26%) from the same time last year. It also came in 2 million above Spotify's forecast, thanks to more premium subscribers signing up than expected. That was especially surprising given the company recently increased the price of its premium plans.
Spotify delivered its first quarterly profit in 18 months
Spotify's users are separated into two classes: premium subscribers who pay a monthly subscription fee, and free users who listen to music with ads. Premium subscribers make up just 37% of the platform's user base, but they contribute 87% of its total revenue, so the addition of more premium subs than expected in Q3 was critical to the company's financial success.
Spotify's revenue came in at 3.4 billion euros ($3.6 billion), an increase of 11% year over year and above the company's estimate. But the real story was at the bottom line, because Spotify delivered its first profit since the first quarter of 2022. It generated a modest Q3 operating profit of 32 million euros, but that was substantially better than the operating loss of 45 million euros it had forecast.
It translated into 65 million euros in net income. But fast premium subscriber growth was only one part of the equation, because Spotify also focused heavily on cutting costs recently amid an uncertain economic climate. Its operating expenses fell 13% year over year during Q3, with marketing spending leading the decline -- which makes the company's rapid subscriber additions even more impressive.
Why Spotify stock is a buy now
Spotify expects growth to continue into the end of 2023, and its forecast suggests it will surpass 600 million monthly users for the first time by year-end. Thanks in part to the recent price increases in its premium plans, that user growth is expected to translate into 3.7 billion euros in revenue, representing a 17% increase year over year. That would be a notable acceleration over Spotify's Q3 expansion rate.
Longer term, the company's goal is to reach 1 billion global users by 2030, suggesting there is still plenty of upside to its financials ahead. But Spotify is also working hard to expand the breadth of its product portfolio to increase engagement. When a free user spends more time on the platform, they generate more advertising revenue and they're also more likely to become a paying subscriber to eliminate those ads -- both of those things are a win for the company. And, of course, when Spotify releases new premium-only features, it prompts free users to consider paying.
Spotify is already one of the largest podcast platforms in the world with more than 5 million titles available, but earlier this month, it also launched audiobooks for premium subscribers in the U.K. and Australia. It's still early, but those users have already listened to 28% of the catalog so far, which includes over 150,000 audiobooks spanning genres like fiction, sci-fi, and memoirs.
Spotify is on a strong growth trajectory, and it has a clear product road map that will supplement its long-term ability to acquire and generate paying customers. The company is also likely to be profitable for the foreseeable future, according to management's commentary and projections. Spotify stock has a great chance to continue recovering the ground it lost since reaching its all-time high, and investors might do well to buy it now.
