Don’t Miss the Forest for the Trees with Spotify (NYSE: SPOT)

Spotify NYSE: SPOT was one of the hottest stocks in the market between mid-May and the end of June, with shares nearly doubling in six weeks.

The Swedish streaming company proved it was serious about becoming a podcast powerhouse during that period, signing exclusive deals with Joe Rogan, Warner Brothers, and Kim Kardashian West.

But shares have stagnated since then; they’ve been roughly flat since the beginning of July. Spotify even dipped around 3% on its Q2 earnings report a few weeks ago.

Revenue Missed

In Q2 2020, revenue was 1.89 billion euros, a bit lower than analyst estimates of 1.93 billion euros.

Ad-supported revenue was largely responsible for the miss, declining 21% yoy. The pandemic has hit advertisers; Spotify isn’t the only company that has faced challenges in this space. This isn’t good news but seems like a short-term decline.

Overall, revenue grew 11.1% yoy. In Q2 2019, revenue was up 23.2%, while in Q2 2018, revenue grew 37.2%.

So revenue is continuing to grow, but at a slower rate than before.

But Key Metrics Are Strong

As of the end of Q2 2020, Spotify had 138 million paid subscribers, up 27% yoy, and 299 million monthly active users (MAUs), up 29% yoy. These numbers are up 6.2% and 4.5%, respectively, over Q1 2020.

Currently, 46.2% of those using the service are paid subscribers, up from an already impressive 45.5% in Q1.

It’s clear that people are adding streaming in a big way since the onset of the pandemic.

And in the Q2 earnings release, Spotify disclosed that 21% of its MAUs engage with podcast content, up from 19% of MAUs in Q1 2020. And consumption of podcasts continues to grow at triple-digit rates yoy.

CEO Daniel Ek talked about where Spotify is heading on the earnings call:

"Every piece of content that we're adding on the service, that we're successfully serving to our consumer, we're creating more engagement," Ek told analysts. "Now that we have almost 300 million monthly active users on the platform, these users are also sharing [when they find great shows] on social media and other forums to other consumers, as well, driving this virtuous cycle where more and more people are learning about what's going on on Spotify and more and more creators want to be on Spotify."

The company sounds a lot like the music/podcast version of Netflix NASDAQ: NFLX… Except its market cap is less than one-quarter of Netflix’s.

Average Revenue Per User is Down, But Consider the Context

In Q2, average revenue per user (ARPU) was 4.41 euros, down 9% yoy.

Spotify attributed the decline to a shift in product mix. The company’s family plan, for example, costs $15 and allows six users to access the service. This can be up to 4x cheaper, per person, than the individual user plan, if a family of six takes advantage of the offer.

The decline in ARPU is partially due to legitimate shifts to family plans. But there is certainly some illegitimate sharing going on. And it’s something that Netflix has struggled with for years.

In 2016, Netflix CEO Reed Hastings seemed to accept illegitimate password sharing, saying, “No plans on making any changes to password sharing. It’s something you have to get used to. Because there’s so much legitimate password sharing.”

A lot has changed since, and Netflix has started to crack down on illegitimate password sharing, but it remains an issue.

Spotify has taken a tough stance on the matter, explicitly stating that the family plan is only for “family members residing at the same address.” On top of that, Spotify requires new accounts to verify their address using Google Maps and “may from time to time ask for re-verification” of the home address.

Don’t expect ARPU to increase much from here – but there is a good chance it will begin to stabilize.

Look For a Breakout

Spotify shares have taken a much-needed breather over the past two months, trading between around $243 and $299. They currently sit near the mid-point of that range.

Look for a move to the top of that range, followed by a short-term consolidation for a week or two. If that culminates in a convincing breakout, look to get in.

Trade With The Trend

Monthly active users and premium subscribers are expected to continue to see high growth in Q3 and Q4 2020 – and probably well-beyond then. Bet on the market returning its focus to these all-important long-term metrics.

Investors are unlikely to demand high earnings from Spotify for the foreseeable future, so you shouldn’t be too concerned about the company’s near-term profitability.

We’ve seen how revenue and subscriber growth can propel share prices for several years with growth machines like Netflix and Amazon (NASDAQ: AMZN).

Your best move with Spotify is get in when an entry point presents itself, place a stop-order to limit your downside, and ride the trend for as long as it lasts.