Spotify’s (SPOT) recent gains have been absolutely astounding. Over the past year alone, the stock has skyrocketed by 170%, with this week’s Q4 results appearing to justify every bit of that surge. Since last Tuesday’s earnings call, SPOT has climbed 15%.
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We’ve seen a perfect storm of rising subscriptions, growing advertising revenue, and expanding economies of scale driving Spotify’s profitability narrative forward. The company’s net income and free cash flow are indeed surging.
And yet, as promising as all this is, I have a hard time reconciling the stock’s hefty valuation in relation to its market performance. The stock is top-heavy as bullish fatigue sets in, so waiting for a pull-back is the best strategy before initiating any long positions.
Strong Growth Momentum Driving Revenue Higher
To begin with, I ought to give Spotify the credit it deserves, as its latest quarter once again highlighted its impressive growth momentum. The company’s monthly active users (MAUs) soared 12% year-over-year to 675 million, while premium subscribers, Spotify’s revenue engine, increased 11% year-over-year to 263 million. These metrics topped consensus expectations and showed Spotify’s consistent ability to attract new users and convert them into paying subscribers.
Accordingly, revenue for the quarter reached €4.24 billion, which is 16% year-over-year. Specifically, premium revenue alone surged 17% to €3.7 billion, boosted by 11% more subscribers and a 5% increase in Average Revenue Per User (ARPU). The ARPU growth is particularly noteworthy, as it shows Spotify can implement price hikes and not only experience churn but continue subscriber ads at a rapid pace. On the advertising side, Spotify raked in €537 million, a 7% increase that might have been even stronger if not for ongoing headwinds in the broader advertising market.
Spotify’s momentum was further evidenced by its annual Wrapped campaign. Each year, we see Wrapped drive remarkable engagement, and this time, it served as a key tailwind, especially in growth markets like Brazil and Indonesia. Meanwhile, Spotify’s video podcast expansion gave creators broader monetization opportunities, translating to more ad dollars in the company’s pocket.
Economies of Scale Push up Profitability
For a long time, skeptics (myself included) questioned if Spotify could ever shake off the razor-thin margins tied to hefty royalties for music labels and artists. In recent quarters, we have seen a highly positive development in that regard. In Q4, the gross margin expanded by a staggering 555 basis points year-over-year to 32.2%, with improvements in premium and ad-supported segments driving that figure higher.
One of the most effective levers here was Spotify’s incrementally raised prices. Since Spotify has become essential to many people’s daily routines, these price hikes, though never universally popular, haven’t led to a mass exodus of subscribers. Another benefit is Spotify’s relatively light capex requirements. The company doesn’t need to build massive data centers or invest in chips to provide its service. As a result, SPOT can convert a significant portion of its operating cash flow directly into free cash flow.
This was evident in Q4, with free cash flow hitting €877 million, up 121% year-over-year. Further, free cash flow reached a remarkable €2.3 billion for the full year. At this pace, I believe that free cash flow will reach €3 billion this year, which should give Spotify’s management great financial flexibility. It could, for example, allow Spotify to initiate a dividend or buy back more stock.
SPOT’s Stretched Valuation Could Derail Returns
Despite these positives, I can’t ignore the elephant in the room: Spotify’s valuation. The stock’s surge has pushed its forward price-to-earnings ratio to about 59x, using the consensus 2025 fiscal EPS estimate of €10.59. That’s steep, even with earnings expected to balloon by 85% next year.
Does Spotify deserve a premium? In many respects, yes. It is dominating the space that boasts a scale and reach that even Apple Music and Amazon Music have struggled to match despite their parent companies’ deep pockets. Clearly, Spotify’s cross-platform availability, personalization features, and ever-expanding content library have contributed to a loyal and sticky user base.
However, history has taught me that even top-tier growth stories can face painful valuation resets if the market perceives a deceleration in their key metrics. If, for instance, subscriber growth cools faster than expected or if ARPU gains stall, the market may suddenly reconsider paying such a high multiple for SPOT shares. And while I remain optimistic about Spotify’s long-term trajectory, I’d be remiss not to point out that lofty valuations can weigh heavily on stocks when sentiment shifts.
Is Spotify (SPOT) a Good Stock to Buy?
Following the stock’s prolonged rally, there may be some bullish fatigue. The stock carries a Moderate Buy consensus rating from a mix of 21 Buy and nine Hold ratings. Notably, not a single analyst rates SPOT as a Sell. Currently, SPOT stock carries an average price target of $620.40 per share, which implies less than 1% downside from current price levels.
Hefty SPOT Valuation Set for Correction
Spotify’s top and bottom-line momentum is certainly noteworthy. Still, the question regarding the stock’s steep valuation remains, especially if growth stalls. At such a premium multiple, I believe the risk for investors is very high as sentiment can shift quickly. Hence, even though I’m impressed by Spotify’s user metrics and operating leverage, I now hold a bearish stance, given how inflated the stock’s price seems following its prolonged rally.
