Spotify Technology (NYSE:SPOT) is back in focus after stronger than expected first quarter results, new guidance pointing to €4.8b in second quarter revenue, and a Peloton partnership that adds more than 1,400 fitness and wellness classes.

Despite the upbeat Q1 earnings, fresh Q2 guidance and the Peloton content deal, Spotify’s recent momentum has cooled, with a 30 day share price return of 11.54% and a year to date share price return of a 25.66% decline, while the three year total shareholder return of about 190.65% and five year total shareholder return of about 96.91% still reflect a much stronger longer term run.

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So with Spotify guiding to €4.8b in Q2 revenue, reporting €721m in Q1 net income and trading around $427 a share, is the recent pullback a potential entry point, or are markets already pricing in future growth?

Most Popular Narrative: 39.2% Undervalued

On the most followed valuation narrative for Spotify, the fair value sits at $703.12 per share versus the last close of $427.43. This is a wide gap that hinges on long term cash flow strength.

“As the business ramps up monetization of content, achieves better deals with the labels, reduces growth expenditure and relies less on music, I expect its gross and net margins will improve considerably, which will also change the way investors value the stock.”

The narrative leans on higher margins, rising revenue and a richer profit profile, all compounding into a much larger free cash flow stream than today.

According to MichaelP, this view of Spotify’s future ties together assumptions on user growth, pricing power, expanding gross margins and a higher long run profit margin, all discounted back using an 8% rate to arrive at a fair value of $703.12 per share.

Result: Fair Value of $703.12 (UNDERVALUED)

However, this depends on Spotify maintaining its market share edge, while risks related to label negotiations and podcast or advertising execution do not limit margins or free cash flow.

Next Steps

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.