The "Magnificient Seven" stocks have dominated the market since the start of 2023. Leading the broad indices to new highs, these seven companies -- all of which have had a market capitalization of at least $1 trillion at some point -- have become the backbone of the modern stock market. Businesses like Alphabet and Apple have demolished most of their competitors, such as Yahoo and Blackberry.
Investors might think it is impossible to compete with the Magnificent Seven tech stocks at this point. But that is not the case in every sector. Enter Spotify (SPOT 0.20%). The leading music and audio streaming service has blazed its own path worldwide despite major competition from the likes of Apple, YouTube, and others. With the stock up 222% since the start of 2023, is now the perfect time to hop on the Spotify growth train?
Beating Apple and YouTube despite disadvantages
Spotify is well-known for its audio streaming application. It allows users to play any music from around the world -- along with podcasts and audiobooks -- with only an internet connection. To make money, Spotify charges users a monthly subscription to access music without advertisements, along with a few other features. This is where the majority of its $14.4 billion in annual revenue comes from today. Since going public in 2018, Spotify's revenue is up 209% in U.S. dollars. Since 2015, its premium subscribers have grown from 28 million to 236 million.
It has done so despite intense competition from Apple and YouTube (which is owned by technology conglomerate Alphabet). Apple released Apple Music in 2015, which was a copycat of Spotify's service. It has since reached an estimated 100 million paying users, while Spotify has added 200 million paying users. YouTube Music now has an estimated 100 million paying users as well. While both competing services are sizable, it is remarkable that Spotify is still winning, considering both Apple's and YouTube's services are bundled with other products at a heavy discount to Spotify.
These companies also own the two distribution platforms for Spotify's service: the IOS and Android mobile operating systems. Spotify has claimed for years that both Apple and Alphabet have acted anticompetitively by prioritizing their own applications over Spotify's on their respective mobile app stores. Now, governments are starting to agree.
Earlier this year, the European Union fined Apple $2 billion for specific anticompetitive behavior against music streaming services (meaning Spotify). Despite Apple and Alphabet both trying to cripple Spotify's business, it continues to thrive. I think that shows how powerful a service it is in consumers' eyes.
2024 is the year profits finally arrive
Spotify has always grown quickly but without generating a profit. Investors soured on the business in 2022 as management once again pushed out profits to future years. Now, it looks like the year of profits is finally arriving.
The company has gone through major layoffs after hiring too many people in 2020 and 2021 while also trying to eliminate redundant costs across its business operations. In the fourth quarter of 2023, Spotify would have generated a positive operating profit if you excluded its one-time severance costs.
The business keeps growing, even with fewer employees. I think this means profits are probable in 2024. Margins keep moving higher, and revenue is still growing at a double-digit rate (16% year over year in Q4, for example). Over the long term, management expects the business will hit 10% or higher profit margins, given its unit economics. These aren't the sky-high margins you might see at other technology companies, but after 2024, it will be hard to claim that Spotify has an unviable business model.
SPOT Revenue (TTM) data by YCharts. TTM = trailing 12 months.
Should you buy the stock?
After its massive run-up, Spotify now sports a healthy market capitalization of $50 billion. Assuming it can reach a 10% profit margin in the next few years, its $14.4 billion in revenue would turn into $1.44 billion in earnings. That gives the stock a (theoretical) price-to-earnings ratio (P/E) of 35, a significant premium to the market average.
With Spotify's premium P/E multiple, investors need to expect the company to grow quickly to fulfill its current valuation -- and Spotify is doing just that, with revenue growing at a double-digit rate in 2023. There is still plenty of room for the music streaming market to grow worldwide, with the company making large pushes into podcasts and audiobooks to drive further gains.
If Spotify can keep growing revenue at a healthy rate, the stock still looks reasonably valued at these prices. Don't be afraid to buy shares just because it is up over 200% since the start of 2023.
