3 Reasons to Be Wary of the Coronavirus Rally in Spotify Stock

The best of the coronavirus-inspired rally in Spotify stock has already come and gone

Shares of music streaming service Spotify (NYSE:SPOT) have surged to 52-week highs amid the novel coronavirus pandemic on the idea that consumers are increasingly spending time and money on music streaming services. SPOT stock is up 17% over the past month on this thinking.

SPOT stock
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Ostensibly, that makes a ton of sense. And Spotify’s first-quarter numbers confirmed as much. The company slashed its full-year revenue guide, but the cut was entirely from weaker ad revenues while premium subscriber growth trends remained robust.

So, does that mean it’s time to chase the red-hot coronavirus-inspired rally in SPOT stock?

I don’t think so. Instead, I think there are three big reasons why investors should be wary of the coronavirus rally in Spotify stock.

  1. The coronavirus tailwind that investors are hoping for may underwhelm.
  2. The valuation underlying SPOT stock is now stretched. Further upside may be hard to come by.
  3. Spotify will run into some serious technical resistance around $160 — a level it has failed to sustainably crack six times since early 2019.

Don’t Buy Into the Coronavirus Tailwind Hype

The bull thesis that “everyone is at home so everyone is listening to more music” ostensibly makes sense. But it doesn’t tell the whole story.

Traditionally, a lot of music streaming time is done in cars, when employees are commuting to and from work or when consumers are commuting to and from the mall, a dinner or a show. Athletes also stream music at the gym, plugging into a Spotify playlist to get “in the zone” during a workout.

But people aren’t spending much time in cars these days, or in gyms. Sure, they are listening to music more at home while working, or through connected devices during at-home workouts. But lost commute and gym time offsets these tailwinds.

Spotify’s second-quarter guide implied as much. While premium subscriber growth in the first quarter accelerated to 30%, the company expects it to fall to 25% in the second quarter. Ad-supported usage growth is expected to similarly decelerate, as is total revenue growth.

With Spotify stock trading at 52-week highs, coronavirus tailwinds are priced in, but the headwinds are not. That’s not a recipe for safety or success.

SPOT Stock Has a Rich Value

According to my modeling, Spotify stock is presently in slightly overvalued territory.

My model makes a few very basic yet ultimately optimistic assumptions about Spotify’s long-term growth trajectory, including:

  1. Sustained double-digit user growth to over 400 million premium subscribers by 2030.
  2. Almost 15% annualized revenue growth to over $30 billion in revenues by 2030.
  3. Significant profit margin expansion from slightly negative operating margins today, to roughly 8% operating margins at scale.

Even under all those assumptions, I still only get to about $11 in earnings per share for Spotify by 2030. That may seem like a lot — the company currently reports net losses — but it’s not enough to justify a $160 price tag.

Based on a 30 times forward exit multiple and a 10% annual discount rate, that implies a 2020 price target for SPOT stock of roughly $140.

With that in mind, Spotify stock has a rich value today. Further gains will be hard to come by.

Spotify Faces Big Technical Resistance

Spotify is also running into big technical resistance around current levels.

Since early 2019, SPOT stock has made six big runs toward $160. These runs came in February 2019, August 2019, November 2019, January 2020, February 2020 and April 2020.

A few of the times, Spotify did indeed break through the $160 level. But never — not once in six tries — did SPOT stock sustainably hold the $160 level.

In that sense, $160 has been a major technical resistance level for SPOT stock.

Shares are flirting with that big resistance level today. History suggests — alongside the fundamentals — that it’s unlikely Spotify breaks through and holds $160 this time around.

Bottom Line on SPOT Stock

I’m a huge fan of the Spotify business model and growth strategy. The company is gradually taking over the music streaming industry using a best-in-breed mobile experience, data-driven song recommendations and original podcast content. It’s a winning strategy which will help the company sustain huge user and revenue growth over the next few years.

But, at current levels, it’s not worth chasing the rally in Spotify shares. The fundamentals aren’t as good as they appear. The valuation is stretched. And the stock is about to run face-first into a big technical resistance level.

Don’t be surprised if the current rally in SPOT stock flops soon, and if shares retreat back to $130 or lower. If they do, consider buying that dip. Until then, hold off on chasing the rally.

Luke Lango is a Markets Analyst for InvestorPlace. He has been professionally analyzing stocks for several years, previously working at various hedge funds and currently running his own investment fund in San Diego. A Caltech graduate, Luke has consistently been rated one of the world’s top stock pickers by various other analysts and platforms, and has developed a reputation for leveraging his technology background to identify growth stocks that deliver outstanding returns. Luke is also the founder of Fantastic, a social discovery company backed by an LA-based internet venture firm. As of this writing, he did not hold a position in any of the aforementioned securities. 

Article printed from InvestorPlace Media, https://investorplace.com/2020/05/3-reasons-to-be-wary-of-the-coronavirus-rally-in-spotify-stock/.

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