Spotify Technology S.A. SPOT shares have gained 18% over the past three months against the 14% decline of its industry.

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Spotify's music streaming rivals have seen losses in the past three months, with Apple AAPL losing 12%, Amazon AMZN 21% and Alphabet GOOGL 20%. Despite this, Amazon, Apple, and Alphabet continue to dominate in other sectors, which may raise questions about whether Spotify can maintain its momentum in such a competitive landscape.

Given the rise in SPOT’s shares, investors may feel inclined to ride the rally. However, the crucial question remains: Is this the right time to invest in Spotify, especially considering the performance of giants like Amazon, Apple, and Alphabet? Let us evaluate.

Content Quality, Price Hikes are SPOT’s Growth Drivers

A high-quality content inventory significantly boosts monthly active users (MAU), driving its revenues. In addition to that, the annual Wrapped campaign is a major driver behind MAU and subscriber growth. In the fourth quarter of 2024, MAU increased by 35 million to 675 million in total, surpassing the management’s previously provided guidance by 10 million. Furthermore, premium revenues grew 19% year over year, driven by pricing power on the new user growth, suggesting that a bulk of new active user growth is high-quality paying users that have significant average revenue per user upside once the premium features begin to get monetized.

Spotify's performance has been bolstered by sustained price hikes, a loyal consumer base and significant cost reductions. The ability to raise prices while retaining and expanding its subscriber base is particularly noteworthy. So far, price hikes have had little to no effect on slowing new subscriber demand. As streaming services keep raising prices, SPOT's increases blend in with the competition.

SPOT’s Strong Returns on Capital

Spotify has demonstrated strong capital efficiency, with a trailing 12-month return on invested capital of 23.55%, surpassing the industry average of 21.84%. This highlights the company's effective allocation of resources to generate profitable growth. A higher ROIC suggests that Spotify is utilizing its investments more efficiently than many of its peers, reinforcing its competitive edge in the streaming industry. Consistently strong ROIC figures indicate sound financial management and the potential for sustained long-term profitability.

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Spotify’s Strong Top & Bottom-Line Prospects

Spotify's growth outlook remains strong, with the Zacks Consensus Estimate projecting revenues of $18.9 billion in 2025 and $21.7 billion in 2026, reflecting year-over-year growth of 11.7% and 14.8%, respectively. EPS estimates stand at $10.4 for 2025 and $13.3 for 2026, representing significant increases of 74.3% and 27.8% year over year, respectively.

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These projections indicate Spotify's ability to expand its revenue base while improving profitability. Strong revenue and earnings growth suggest that the company is effectively scaling its business within the highly competitive music-streaming industry.

SPOT’s Liquidity Position Lags Industry

In the fourth quarter of 2024, Spotify’s current ratio of 1.88 underperformed the industry average of 2.54. However, the metric has increased by 10% from the preceding quarter, and a current ratio of more than 1 indicates efficient short-term debt coverage capabilities.

Spotify Stock Looks Overvalued

SPOT’s surge in stock price led to elevated valuations. It is priced at 52.2 times forward 12-month earnings per share, which is higher than the industry’s average of 31.3 times. While the optimism about its growth prospects underpins this premium, maintaining such high multiples may prove challenging. Any deficit in growth expectations could result in a valuation correction.

SPOT: Wait for the Right Entry Point

The massive rise in SPOT’s shares can be attributed to strong top-line growth and improved pricing power. Inclination towards maintaining a high content quality and a surge in MAUs paves the path for the company’s long-term success. A robust liquidity position and an optimistic top and bottom-line outlook are added advantages.

Meanwhile, the company faces significant headwinds in the form of heightened competition, reliance on third-party licenses, and inflated valuation. Trading at a forward P/E of 54.8X, above the industry average, might hinder the near-term growth.

Investors are recommended to adopt a “Hold” strategy, awaiting vivid signs of sustained growth and a potential pullback in its valuation before increasing exposure.

Spotify carries a Zacks Rank #3 (Hold) at present. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

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This article originally published on Zacks Investment Research (zacks.com).

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