🎙️🎵Business Overview

🎯Key Metrics

Total: -1/17

• +1 ✅ Projected Operating Margin: 17.56%
• +1 ✅ Projected 5-Year Revenue CAGR: 10.87%
• +0 ⚠️ Last 5-Year ROIC: 4.68%
• -2 ❌ Estimated Cost of Capital: 7.71% (greater than ROIC)
• -1 ❌ Last 5-Year Shares Outstanding CAGR: +2.07%
• +1 ✅ Projected 5-Year EPS CAGR: 15.46%
• +0 ⚠️ Projected 5-Year Dividend CAGR: N/A
• +1 ✅ Estimated Debt Rating: A1
• -1 ❌ Morningstar Moat: Narrow
• -1 ❌ Morningstar Uncertainty: High

Despite its Narrow Moat rating by Morningstar, Spotify still shows an operating margin around ~15-20% and expanding. Its revenue and EPS growth is also solid between 10-15%. However there could be some uncertainty around this industry, with the introduction of AI generated content and more competitors.

Despite this, I think Spotify will maintain and expand its competitive advantages given its privileged position. Let’s check if its current prices are justified.

📝Business Valuation

To calculate the intrinsic value of the company I’ll use multiple methods:

• Discounted Cash Flows (DCF) – Intrinsic value is estimated by projecting its free cash flows over the next 10 years and discounting them to present value using the estimated cost of capital;
• EPS Growth – the fair value is estimated by projected the Earnings Per Share CAGR for the next 5 Years and then, given its current and historic values of PE, come up with a PE for the 5th Year. This will give us its price 5 Years from now using the formula: Price = EPS x PE that we then discount using the estimated cost of capital;
• Historical P/S – we assume mean reversion to the historical P/S values.

Cost of Capital

I’ve used the latest annual financial statement of the company, converting the Euro values to Dollars, the 10-Year German bonds as the risk free rate (given that the company’s country uses Euro) and revenue geographic exposure to come up with its cost of capital, cost of debt and cost of equity. Also, given the fact that Moody’s does not provide a rating for the company I estimated it using the current interest coverage ratio and comparing it to similar rated companies.

Cost of Capital: 7.71%.

This value will be used later as a discount rate in the valuation methods.

Please feel free to come up with your own values by using the tool I’ve used: Cost of Capital – The Fair Value Journal. It is and will ever be completely free 🙂

Discounted Cash Flows (Weight: 50%)

I’ve used the latest annual financial statement of the company, converting the Euros to Dollars, the analyst estimates for both revenue and margins and the cost of capital calculated previously.

Some notes on the inputs above:

• Terminal Revenue Growth – I’m using the risk-free rate (10-Yr bonds of Germany), because long term the company should not grow more than the rate of the economy. I’m using the risk-free rate as a proxy to it, so the terminal growth becomes it;
• Initial and Terminal Cost of Capital – I’m assuming for both the current estimated cost of capital;
• Initial and Terminal Tax Rate – Given the volatility of the effective tax rate on the last couple of years I’m assuming the industry average;
• Initial and Terminal Sales / Capital Ratio – I’m assuming for both the industry average, given the current volatility of these values for this company.

All the other inputs were taken from the financial statement or from analyst projections.

The DCF gives us an estimated fair value of 348.90 dollars for Spotify.

Something that we can also do now is to play around with Monte Carlo simulations. What this will allow us to do is to simulate multiple DCF valuations with pre-defined ranges for each of the inputs. Each simulation will randomize the inputs between these pre-defined values. For this I also used analysts estimates.

As you can see from the above Spotify seems to be overvalued given that its current price of 445.55 dollars is above P90. From these simulations we can extrapolate that there’s more than 90% probability of Spotify being overvalued.

Please be free, as before, to fill in your own values. Make the valuation your own and do yourself a DCF valuation using your own assumptions: DCF – The Fair Value Journal

EPS Growth (Weight: 40%)

For this valuation method, I’ve used the current EPS and the analysts estimates of EPS growth. I also assumed a 25 PE for the company.

Then again used the Monte Carlo simulations to check what happens when the input values change within a specified range:

Using this valuation method, Spotify that is currently priced at 445.55 dollars seems to be overvalued being currently priced above P90. From this we can extrapolate that there’s more than ~90% probability of the stock being overvalued.

This seems to be in line with the previous DCF output.

As before, feel free to try this yourself: EPS Growth – The Fair Value Journal

Historical P/S (Weight: 10%)

The current P/S (Price / Sales) ratio is around its 7-8 Year average. This means that the company is fairly valued by this metric. Assuming a mean reversion to its historical average of 4.49 we can assume a fair value of 451.26 dollars.

For every type of historical and relative valuation you can use the same free tool: Historical / Relative Valuation – The Fair Value Journal

✍️Summary

Now that we did all the heavy work, let’s take the above and come up with the company weighted average fair value.

I basically take each valuation method used and given my confidence on the company apply a 20% or 10% discount (when to buy) and addition (when to sell) or use the Monte Carlo P10, P20, P80 and P90 values:

Feel free to choose your own values, but for me I’ll probably start buying around 329.53 dollars given my high confidence assumption that Spotify will remain one of the biggest entertainment companies in the world for many years to come.

Overall it seems Spotify is overvalued at the current prices.

Fair Value: 357.76 dollars