Spotify (NYSE:SPOT) and Spotify stock have become adept at survival. After SPOT became one of the first companies to offer internet-based audio streaming, some of tech’s largest companies have become its competitors.
Still, it has managed to survive and thrive despite this threat. As a result, the valuation of Spotify stock has become elevated.
However, survival is not the same as prosperity. SPOT remains a small company that probably could not succeed if it was launched in today’s tech world. Given the peers it must face and its struggles to maintain a profit, I do not think the current valuation of SPOT stock is justified.
Spotify Has Become Adept at Survival
When Daniel Ek and Martin Lorentzon founded Spotify in 2006, streamed music was not yet a big business. SPOT used this first-mover status to make itself the $25.5 billion company it has become today.
However, the Sweden-based streaming-music company must now contend with the dominant ecosystems of tech mega-caps such as Apple (NASDAQ:AAPL), Alphabet (NASDAQ:GOOGL, NASDAQ:GOOG), and Amazon (NASDAQ:AMZN).
Rather than get pushed out of existence, SPOT has wisely chosen to attach itself to a large ecosystem; specifically, it has joined forces with Samsung (OTCMKTS:SSNLF). In conjunction with this alliance, Samsung will pre-install Spotify’s service on all of its Galaxy devices. As a result, SPOT will be the preferred music provider on over 24% of U.S. smartphones.
SPOT has also turned to original content. It bought both Gimlet Media and a creation app called Anchor back in February to help it develop unique content.
Why Spotify Stock Is Overvalued
I think both moves will help Spotify, at the very least, survive . Still, saving Spotify does not fully equate to saving SPOT stock.
SPOT stock bulls will point to analysts’ consensus estimate of 26.7% revenue growth this year and 23.8% in 2020. But investors still need to ask whether those forecasts justify the current rich valuation of Spotify stock.
SPOT was profitable in Q4. However, analysts on average do not expect it to generate annual profits until 2022. At today’s stock price, Spotify’s 2022 forward price-earnings (PE) ratio, based on the consensus outlook, is over 100! Further, Spotify stock is currently trading at about 10.75 times the company’s book value.
If SPOT had its own ecosystem, the current multiples of SPOT stock might be justified. However, the company remains a small fish swimming in a sea of sharks that could easily swallow it. SPOT has obtained a powerful ally in Samsung that could ensure its survival.
However, I do not think the current value of SPOT stock prices in the risk of the company going under. Given the dangers SPOT still faces, I would not pay a premium valuation for SPOT stock.
Moreover, at this multiple, investors appear to be treating Spotify stock like it has become the Netflix (NASDAQ:NFLX) of audio streaming. SPOT’s new content-development strategy could succeed. However, for SPOT to earn money from content, it must create compelling content.
It’s unclear how listeners will respond to Spotify’s content. But in my view, Spotify stock needs to price in SPOT’s risk for the shares to be a good investment.
The Bottom Line on Spotify Stock
SPOT has managed to ensure its survival and create a fast-growing revenue stream. However, given the many dangers SPOT faces, the current valuation of SPOT stock is excessive. Spotify’s alliance with Samsung has improved the outlook of SPOT. Also, SPOT’s original content could draw more listeners.
Still, SPOT’s survival depends on its relationship with Samsung, and to a degree, on its success with original content.
With Spotify stock trading at more than 100 times analysts’ consensus 2022 earnings estimate, I do not think investors have priced this risk into Spotify stock. Until SPOT stock reflects these misgivings, investors should not pay the premium multiple of SPOT.
As of this writing, Will Healy did not hold a position in any of the aforementioned stocks. You can follow Will on Twitter at @HealyWriting.