The Rally in Spotify Stock Looks Like It’s Going to Stall out at $150

Spotify stock is fully valued, technically maxed out, and staring at escalating profit headwinds

When it comes to shares of music streaming giant Spotify (NYSE:SPOT), I’ve played both the bull and the bear. The bear came out shortly after Spotify’s red-hot debut on Wall Street during 2018, in which Spotify stock soared to a $200 price tag in a hurry.

The Rally in Spotify Stock Looks Like It's Going to Stall out at $150
Source: Kaspars Grinvalds / Shutterstock.com

I felt that the rally was overdone and that slowing growth coupled with competition concerns and valuation friction would ultimately short-circuit the rally. Shortly thereafter, Spotify plunged from $200, to $100.

Then, in 2019, the bull came out. At $100, Spotify was just too cheap to ignore. Plus, increasing investment in podcasts was a positive step towards constructing a content moat, while global expansion and mobile app improvements laid the groundwork for sustained big user growth. In 2019, the stock rose about 30% to a $150 price tag.

Now, in 2020, I think it’s time for the bear to come back out. That’s not to say that Spotify stock will tumble from here. I don’t think it will. But, escalating margin headwinds and widening losses will limit the upside in the stock over the next few quarters.

Here’s why.

Profit Headwinds Will Get Worse

Spotify doesn’t have a growth problem. It has sustained huge user and revenue growth on a global scale for several years. The growth will likely continue to do so over the next few years as the company leverages a best-in-class app experience with original podcast content and data-driven music recommendations to take over the global streaming music industry.

But, Spotify does have a profit problem. And that profit problem will only get worse in 2020.

Spotify runs at 25% gross margins. That’s pretty low. It’s pretty low because the company pays out huge royalty fees to the musicians and singers who own the content which Spotify sells.

Meanwhile, Spotify runs at a 25%-plus operating expense rate. Thus, Spotify has a profit problem (operating expenses are bigger than gross profits), and this problem only gets fixed if: 1) gross margins move way higher, or 2) the operating expense rate moves way lower.

But, in 2020, neither of those will happen. Instead, gross margins will actually move lower, as the company invests more heavily in podcast content acquisition and development. Gross margins are projected to drop by more than 100 basis points to below 25% in 2020.

At the same time, Spotify’s growth is predicated heavily on its mobile app experience, so while expense growth rates may moderate going forward, they won’t moderate by much. Also, podcast content integration requires heavier opex. That’s why Spotify is calling for its operating loss to actually widen next year, not narrow.

All in all, then, Spotify’s big profit problem will only get worse in 2020, and that’s bad news for Spotify stock.

Spotify Is Running into Resistance

In addition to staring at escalating profit headwinds in 2020, Spotify stock is also running into some major valuation and technical resistance at current levels.

Take a look at the chart. Since early 2019, this stock has formed a clear line of technical resistance around $150 to $160. In February 2019, the stock was turned around at $150. In August 2019, the stock was again turned around at $150. And, in January 2020, the stock’s big rally again stalled out at, you guessed it, $150.

That’s three times over the past year that the Spotify rally has stopped in the $150 range. That’s not a great sign. From a technical perspective, you’d want to see Spotify stock breakout above $160 before buying into shares at these technically challenged levels.

Even further, Spotify stock presently sports a 4-times trailing sales multiple. Much like the $150 price level, a 4-times trailing sales multiple has historically been the “ceiling” for this stock. That is, anytime the trailing sales multiple shoots above 4, the stock usually tops out and reverses course.

All in all, this stock is running into some serious technical and valuation resistance at $150 and 4-times trailing sales, respectively. That resistance, coupled with escalating profit headwinds, implies that shares may fall flat over the next few months.

Bottom Line on Spotify Stock

Spotify stock was a great buy in 2019. In 2020, not so much. Shares appear both fully valued and technically maxed out here. At the same time, the optics aren’t great, as the company’s profit problems will only get worse amid widening losses.

Put all of that together, and it’s quite likely that the big Spotify rally stalls out here and now.

As of this writing, Luke Lango did not hold a position in any of the aforementioned securities.


Article printed from InvestorPlace Media, https://investorplace.com/2020/02/the-rally-in-spotify-stock-looks-like-its-going-to-stall-out-at-150/.

©2020 InvestorPlace Media, LLC