Spotify Technology (NYSE: SPOT) reported terrific earnings last week, growing paying subscribers 14%, monthly active users 19%, and revenue 20% year over year. Spotify even flipped from a year-ago loss to a $1.05-per-share profit in the first quarter of 2024.
On Wednesday, Deutsche Bank urged investors to buy Spotify stock, and gave Spotify the highest price target of any analyst on Wall Street: $400 a share.
Key to Deutsche Bank’s buy rating on Spotify was the streaming music company‘s confirmation that its gross profit margins are still rising, hitting 27.6% in Q1. Management hopes to hit a 30% gross profit margin sometime between 2025 and 2027, and the Q1 result was so close to that mark that it’s looking at least possible Spotify will reach its goal within the next year.
Now, a better gross profit margin, plus improved control over costs, imply better operating profits, and better net profits as well. As Spotify proves it’s capable of achieving these goals, Deutsche Bank predicts more analysts will upgrade the stock, forcing Spotify’s stock price even higher. Hence the $400 price target.
But exactly how profitable must Spotify be to justify a $400 share price? Taking a standard PEG ratio approach to valuation, let’s assume Wall Street’s consensus forecasts for Spotify’s growth rate are correct: Spotify is going to grow at 38% annually over the next five years; $400 divided by 38 equals $10.52. Thus, for Spotify to be worth $400 a share, you’d want to see it earning about $10.52 per share today.
And that’s the problem.
In Q1, Spotify earned $1.05 per share. Annualized across four quarters, that works out to $4.20 per share, or less than half of what the stock should be earning to justify a $400 share price. Even assuming that profits keep trending upward over the course of this year, I still see Spotify stock as roughly 100% overvalued at present levels.
For this reason, I conclude that Spotify stock is not a buy.
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Rich Smith has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Spotify Technology. The Motley Fool has a disclosure policy.
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