Spotify: A Scalable Growth Story

Spotify is the world’s largest audio streaming platform, offering music, podcasts, audiobooks, and video content to hundreds of millions of users across 184 countries. Built on a freemium model, data-driven personalization, and a strong global brand, Spotify has established itself as a leader in the digital audio industry. With ongoing investments in podcasts, video, advertising, and emerging markets, the company is positioning itself for long-term growth beyond music streaming. The question remains: Should this audio giant have a place in your portfolio?

This is not a financial advice. I am not a financial advisor and I only do these post in order to do my own analysis and elaborate about my decisions, especially for my copiers and followers. If you consider investing in any of the ideas I present, you should do your own research or contact a professional financial advisor, as all investing comes with a risk of losing money. You are also more than welcome to copy me. 

For full disclosure, I should mention that I do not own any shares in Spotify at the time of writing this analysis. If you would like to copy or view my portfolio, you can find instructions on how to do so here. If you want to purchase shares or fractional shares of Spotify, you can do so through eToro. eToro is a highly user-friendly platform that allows you to get started on investing with as little as $50.

The Business

Spotify Technology operates the world’s largest audio streaming platform, offering access to music, podcasts, and audiobooks across 184 countries. Founded in 2006 and launched in 2008, Spotify transformed the way people consume audio by shifting the industry from a transaction-based model of buying songs to an access-based model of streaming. Its platform provides more than 100 million tracks, 6,5 million podcast titles, and 350.000 audiobooks. The company runs a freemium model with an ad-supported free tier and a paid Premium tier. Premium subscriptions contributed around 88% of Spotify’s revenue in 2024, providing a stable, recurring revenue base, while the ad-supported segment contributed the remaining 12%, growing through initiatives in podcasting and innovative ad formats. This dual-revenue model has allowed Spotify to revolutionize music consumption and capture a leading share of the global streaming market. Europe and North America remain Spotify’s largest markets, representing about 63% of its Premium users, but the company is expanding rapidly in Latin America and the Rest of the World as streaming adoption accelerates globally. Beyond music, it continues to invest in broadening its ecosystem with podcasts, audiobooks, and video formats, aiming to deepen user engagement and unlock new monetization opportunities. Spotify’s competitive moat is anchored in its scale, brand strength, technology, and deep user engagement. With 675 million monthly active users, the platform collects vast amounts of listening data, fueling sophisticated recommendation algorithms that drive highly personalized user experiences. This personalization strengthens user loyalty and positions Spotify as an essential partner for artists, labels, and publishers seeking broad distribution and influence. Its freemium model and platform-agnostic approach give it a growth funnel unmatched by rivals like Apple Music and Amazon Music, which often focus on subscription-only or bundled offerings. By being accessible across all major operating systems and devices, Spotify has been able to expand globally, particularly in mobile-first markets. The brand is deeply embedded in youth culture worldwide, helped by iconic features like Spotify Wrapped and the platform’s influential playlist ecosystem. Years of personalized playlists and listening histories create significant user stickiness and high switching costs. User engagement on Spotify is among the highest across entertainment platforms, and this strong engagement drives superior lifetime value, which has become increasingly important as the company shifts its focus from scaling to profitability. Scale has become a fundamental driver of Spotify’s improving financial performance. After years of prioritizing user growth over profits, its operating leverage is now materializing, demonstrating that greater scale not only enhances the user and creator experience but also drives expanding margins and profits.

Management

Daniel Ek serves as the CEO and is co-founder of Spotify, a company he helped establish in 2006. He brings a strong entrepreneurial background and a deep personal commitment to the company's long-term success. Daniel Ek’s entrepreneurial journey began early; at the age of 13, he started creating websites from his home and later recruited classmates to help build websites using school computers, offering video games as incentives. By the time he turned 18, he was already earning $50.000 a month. Before founding Spotify, Daniel Ek held several positions across different technology companies and also founded and sold another business, gaining valuable experience in the startup world. Although he initially pursued engineering studies at the KTH Royal Institute of Technology in Stockholm, he eventually decided to leave academia to focus full-time on his entrepreneurial endeavors. Daniel Ek has spoken openly about his leadership philosophy, describing it as authentic and rooted in self-awareness. He emphasizes the importance of understanding one's own values, beliefs, and strengths rather than imitating other leaders. In previous conference calls, he has highlighted his commitment to motivating teams to think bigger, move faster, and raise their ambitions every day. His leadership style is often described as ambitious, purpose-driven, and motivating. Under his leadership, Spotify has grown from a small startup to the world’s largest audio streaming platform, transforming the way people access and enjoy music, podcasts, and audiobooks globally. According to employee feedback collected by Comparably, Daniel Ek enjoys a high leadership rating, ranking him in the top 5% among CEOs of similarly sized companies. Given his entrepreneurial mindset, deep understanding of the business, and proven leadership over nearly two decades, I believe Daniel Ek is exceptionally well-positioned to continue leading Spotify through its next phases of growth and innovation.

The Numbers

The first number we will look into is the return on invested capital, also known as ROIC. We want to see a 10-year history, with all numbers exceeding 10% in each year. Spotify made its IPO in 2018, so we only have numbers from 2018 and onwards. Spotify has achieved a negative ROIC in most years since its IPO. Some of the reasons that have affected ROIC negatively include high content licensing costs, as Spotify pays substantial royalties to record labels and rights holders, often amounting to around 70% of its revenue. This significant expense compresses gross margins and limits profitability. In addition, Spotify has prioritized user growth and market expansion over immediate profitability, leading to increased capital expenditures and investments in new content formats like podcasts and audiobooks. It is not something that worries me, as it is not uncommon for companies in growth phases to report such figures. Spotify’s strategy has focused on scaling its user base and expanding its content offerings, which has required significant upfront investment and impacted short-term profitability. However, Spotify reached its highest ROIC ever in 2024, and management expects the company to remain profitable going forward. Hence, I expect Spotify to achieve positive ROIC in the future.

The next numbers are the book value + dividend. In my old format this was known as the equity growth rate. It was the most important of the four growth rates I used to use in my analyses, which is why I will continue to use it moving forward. As you are used to see the numbers in percentage, I have decided to share both the numbers and the percentage growth year over year. To put it simply, equity is the part of the company that belongs to its shareholders – like the portion of a house you truly own after paying off part of the mortgage. Growing equity over time means the company is becoming more valuable for its owners. So, when we track book value plus dividends, we’re essentially looking at how much value is being built for shareholders year after year. Spotify has managed to increase its equity in most years despite periods of negative ROIC. This reflects several underlying factors. For example, Spotify has generally run an asset-light business model, meaning it does not need heavy investments in physical assets like factories or inventory. This keeps its balance sheet relatively clean and allows retained earnings and capital infusions to have a more visible impact on equity growth. In 2024, Spotify reached its highest equity level ever, marking an important milestone. It signals that the company's earlier investments are starting to translate into real, retained value for shareholders. As Spotify continues to grow profitability and scale, building a stronger equity base should enhance financial resilience, support future expansion, and ultimately increase long-term shareholder wealth.

Finally, we will analyze the free cash flow. Free cash flow, in short, refers to the cash that a company generates after covering its operating expenses and capital expenditures. I use levered free cash flow margin because I believe that margins offer a better understanding of the numbers. Free cash flow yield refers to the amount of free cash flow per share that a company is expected to generate in relation to its market value per share. It might be a bit surprising that Spotify has managed to deliver positive free cash flow every year since its IPO despite a negative ROIC in most years. Some of the reasons for this are that Spotify operates with minimal capital expenditures, as it does not require significant investments in physical assets like manufacturing facilities. This capital-light approach reduces the need for large cash outflows, aiding in positive free cash flow. The company also incurs substantial non-cash expenses, such as share-based compensation and depreciation. While these reduce net income, they do not impact cash flow, allowing free cash flow to remain positive. In addition, Spotify often receives payments in advance for its services, especially from annual subscribers. These prepayments are recorded as deferred revenue, boosting cash flow even if the revenue has not yet been recognized. Spotify reached its highest level of free cash flow ever in 2024, and management has stated that they expect free cash flow generation to meaningfully exceed 2024 levels in the future, which is very encouraging. The levered free cash flow margin should also continue to improve. Management has mentioned that using free cash flow for sustainable growth opportunities with attractive return potential remains their top priority. However, they have also indicated that, to the extent excess capacity rises, returning capital to shareholders will be considered, which means that investors could expect buybacks and possibly even dividends over time. The free cash flow yield is currently at its highest level since Spotify's IPO, suggesting that the shares are trading at their most attractive valuation historically. However, a free cash flow yield of around 2% still indicates that the stock is expensive relative to many other opportunities. We will revisit valuation later in the analysis.

Debt

Another important area to investigate is debt, and we want to see whether a business has a reasonable level of debt that could be paid off within three years. To assess this, we divide total long-term debt by earnings. When applying this measure to Spotify, the result shows that it would take approximately 1,3 years of earnings to pay off its long-term debt, which is well below the three-year threshold. Hence, debt would not be a concern for me if I were to invest in Spotify.

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Risks

Competition remains a significant risk for Spotify across both its user growth and its ability to attract advertisers. Spotify faces intense and evolving competition from global technology giants like Apple, Alphabet (Google/YouTube), Amazon, Meta, and ByteDance, all of which have large platforms where users can discover, consume, and share audio and video content. Many of these competitors have much broader hardware, software, and service ecosystems than Spotify, giving them important structural advantages. For example, Apple and Amazon can preload their own music streaming services on devices like iPhones or Alexa speakers, reducing friction for users and giving their own apps a visibility advantage over Spotify. In addition to easier access, these companies often have deeper financial resources, stronger brand recognition, larger user bases, and more experience monetizing audiences. They can afford to offer streaming services at little or no profit, or even at a loss, as part of a larger bundled strategy tied to their broader ecosystems, putting additional pricing pressure on Spotify. App store policies also work against Spotify’s interests: Apple and Google control the platforms through which users often download the Spotify app and can charge fees that do not apply to their own competing services, creating a structural disadvantage for Spotify. Beyond global competition, Spotify also faces threats from local and regional streaming services, particularly in emerging markets. While management notes that regional competitors often lose relevance as markets mature, their presence can still slow Spotify’s growth and increase customer acquisition costs during the early stages of market development. Spotify competes fiercely for advertising budgets as well, not only against other streaming services but also against large internet companies like Google, Facebook, and Amazon. These companies can offer advertisers massive reach, advanced targeting technologies, and integrated advertising ecosystems, making it harder for Spotify to win a meaningful share of advertising dollars even as its ad business grows.

Music licensing and royalty costs are one of the most significant structural risks to Spotify’s long-term profitability. Royalties paid to music rights-holders - including record labels, artists, and publishers - historically consume around 70% of Spotify’s revenue. This means that Spotify’s gross margins are effectively capped by these payments, limiting its ability to significantly expand profitability through traditional growth. Unlike some other digital content businesses, such as Netflix, where content investments are more fixed and do not scale directly with subscriber growth, Spotify’s cost structure is highly volume-driven. Every additional stream by a user triggers a royalty payment, so even as Spotify adds new users or increases listening hours, the associated content costs rise proportionally. This volume-based model limits operating leverage, meaning Spotify cannot easily improve margins simply by growing its user base. Spotify’s dependence on the major record labels - Universal Music Group, Sony Music, and Warner Music - further compounds the risk. These three companies control a large majority of the global music catalog and have strong negotiating power over Spotify. Licensing terms are periodically renegotiated, and if Spotify fails to secure favorable deals in the future, or if regulatory bodies mandate higher royalty rates, it could lead to even thinner margins. While Spotify is actively working to diversify its revenue mix toward higher-margin offerings such as podcasts and audiobooks, the core music business remains constrained by its reliance on licensing from third-party content owners. A failure to materially shift the revenue mix toward owned or more favorable content could weigh on profitability over the long term.

Macroeconomic conditions present a meaningful risk to Spotify’s business across both its advertising and subscription segments. Spotify’s financial performance is closely tied to the broader economic environment, and global factors such as inflation, interest rate changes, trade policy shifts, and geopolitical conflicts can directly impact both its revenue streams and cost structure. One of the most immediate vulnerabilities lies in advertising, which accounts for around 12% of Spotify’s total revenue. Advertising budgets are highly sensitive to economic cycles. In periods of economic downturn or uncertainty, businesses often cut marketing and advertising expenditures to preserve cash. Spotify already experienced this dynamic in 2024, when ad-supported music revenues in the U.S. declined year-over-year. A prolonged or deep recession in key markets could stall or shrink Spotify’s ad business, putting pressure on overall growth and margins. Subscription revenue, which forms the bulk of Spotify’s income, is somewhat more resilient but not immune to macroeconomic pressures. In severe recessions, consumers often reassess discretionary spending. Although Spotify’s Premium service is relatively affordable compared to other entertainment options, a significant economic contraction could lead some users to downgrade to the free ad-supported tier or cancel their subscriptions entirely. This would impact Spotify’s recurring revenue base and slow subscriber growth at a time when scale is crucial to strengthening profitability. Sustained macroeconomic weakness could therefore not only weigh on near-term financial performance but also delay Spotify’s path to expanding margins and building long-term shareholder value.

Reasons to invest

Expanding into new products provides an important long-term growth opportunity for Spotify. Beyond its core music streaming business, Spotify has strategically broadened its platform into podcasts, audiobooks, video podcasts, and even early experiments in educational content. These expansions aim to deepen user engagement, diversify revenue streams, and improve the company’s margin structure over time. The shift into podcasts was an early move, marked by high-profile acquisitions like The Joe Rogan Experience. Podcasts are attractive because they offer Spotify greater control over content economics compared to music licensing, including ownership of advertising inventory. While the initial investments in building a podcast library were substantial, Spotify is now nearing breakeven in the segment, and ad-supported podcasts are becoming an increasingly important pillar of its monetization strategy. Building on its podcast success, Spotify has also expanded aggressively into video podcasts, recognizing that video is becoming a natural extension of audio content consumption. Spotify is enhancing monetization opportunities for creators and offering premium subscribers an ad-free video podcast experience, moves that should help drive both user stickiness and content creator loyalty. In addition, the launch of Spotify’s audiobook catalog, now featuring more than 350.000 titles across multiple markets, taps into another large and growing segment of consumer audio consumption. Audiobooks represent a higher-margin opportunity and align well with Spotify’s goal of becoming the world’s leading audio platform. Looking even further ahead, Spotify is beginning to explore opportunities in educational content - a market potentially as large as entertainment in economic value. Early signs from trials in markets like the U.K. are encouraging, and management emphasizes that Spotify’s platform, where users already consume a mix of entertainment and informational content, is a natural home for educational audio experiences.

Advertising represents a major long-term growth opportunity for Spotify. Historically, Spotify monetized its free-tier user base primarily by selling ads directly to brands through its own sales teams. While effective to a point, this approach limited the scale and efficiency of Spotify’s advertising business because it relied heavily on manual negotiations and personal relationships. To address this, Spotify has shifted toward a more automated approach known as programmatic advertising. Programmatic advertising means that instead of manually selling ads, Spotify now allows advertisers to buy ad space automatically through digital platforms, using real-time data to match ads with users. This makes the process much faster, more scalable, and more efficient, opening Spotify’s inventory to a much larger pool of advertisers. A key part of this transition is Spotify’s decision to integrate with platforms like The Trade Desk, one of the world’s largest programmatic advertising marketplaces. By partnering with The Trade Desk and similar platforms, Spotify’s ad inventory becomes available to thousands of advertisers who use these platforms to place their ads. This means more advertisers can easily access Spotify’s highly engaged audience without needing a direct sales relationship, significantly increasing demand for Spotify’s ad space. By automating ad inventory management and making its unique and highly engaged audio inventory more accessible to advertisers, Spotify is better positioned to capture a larger share of the growing global advertising market, which is projected to double from approximately $1 trillion to $2 trillion over the next decade. Video advertising also represents an emerging area of growth for Spotify, as the expansion of video podcasts and other visual content on the platform will create new high-value ad inventory beyond traditional audio ads. In addition, Spotify’s ability to leverage its massive consumer data set creates a powerful competitive advantage. As the world’s leading audio platform, Spotify has unparalleled insights into user behavior, listening habits, and consumption trends. This deep data allows Spotify to deliver highly targeted and effective advertising solutions, increasing the value it can offer to brands and marketers. Better targeting not only improves ad conversion rates and advertiser satisfaction but also enhances the user experience by making ads more relevant.

Emerging markets represent a compelling long-term growth opportunity for Spotify. While management expects that near- to mid-term profitability will continue to be driven primarily by developed markets such as Europe and North America, the company is seeing increasingly strong momentum in emerging regions like Latin America, India, and Southeast Asia. Spotify’s success in Latin America provides a useful blueprint. Early skepticism about the market’s potential has been replaced by clear evidence that strong engagement can translate into meaningful subscriber growth and a profitable business. The same pattern is now beginning to unfold in other emerging regions. In the second half of 2024, Spotify saw clear signs of progress, with strong monthly active user growth and positive subscriber net additions from emerging markets. The company’s strategy centers around increasing engagement first, knowing that high engagement typically leads to higher conversion rates from free users to paying subscribers over time. Initiatives such as localized music offerings and culturally relevant features like Wrapped have been especially effective. For example, Wrapped saw record-breaking engagement in growth markets like Brazil and Indonesia, reinforcing Spotify’s brand strength and emotional connection with users in these important regions. Although profitability in emerging markets tends to lag behind developed markets due to lower average revenue per user and higher acquisition costs, the long-term potential is significant. As economies mature and consumer spending power increases, these large and young populations offer a massive runway for subscriber growth and future revenue expansion. Management believes that over time, countries like India will become substantial and profitable contributors to Spotify’s global business.

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Valuation

Now it is time to calculate the share price. I perform three different calculations that I learned at a Phil Town seminar. If you want to make the calculations yourself for this or other stocks, you can do so through the tools page on my website, where you have access to all three calculators for free.

The first is called the Margin of Safety price, which is calculated based on earnings per share (EPS), estimated future EPS growth, and estimated future price-to-earnings ratio (P/E). The minimum acceptable rate of return is 15%. I chose to use an EPS of 5,70, which is from the year 2024. I have selected a projected future EPS growth rate of 15%. Finbox expects EPS to grow by 35,3% over the next five years, but 15% is the highest number I use. Additionally, I have selected a projected future P/E ratio of 30, which is double the growth rate. This decision is based on Spotify's historically higher price-to-earnings (P/E) ratio. Finally, our minimum acceptable rate of return has already been established at 15%. After performing the calculations, we determined the sticker price (also known as fair value or intrinsic value) to be $171,00. We want to have a margin of safety of 50%, so we will divide it by 2. This means that we want to buy Spotify at a price of $85,50 (or lower, obviously) if we use the Margin of Safety price.

The second calculation is known as the Ten Cap price. The rate of return that a company owner (or stockholder) receives on the purchase price of the company essentially represents its return on investment. The minimum annual return should be at least 10%, which I calculate as follows: The operating cash flow last year was 2.384, and capital expenditures were 18. I attempted to analyze their annual report to calculate the percentage of capital expenditures allocated to maintenance. I couldn't find it, but as a rule of thumb, you can expect that 70% of the capital expenditures will be allocated to maintenance purposes. This means that we will use 13 in our calculations. The tax provision was 210. We have 202,1 outstanding shares. Hence, the calculation will be as follows: (2.384 – 13 + 210) / 202,1 x 10 = $127,71 in Ten Cap price.

The final calculation is referred to as the Payback Time price. It is a calculation based on the free cash flow per share. With Spotify's free cash flow per share at $11,71 and a growth rate of 15%, if you want to recoup your investment in 8 years, the Payback Time price is $184,85.

Conclusion

I believe that Spotify is an intriguing company with great management. The company has built a moat through its scale, brand strength, technology, and deep user engagement. While Spotify has achieved a negative ROIC in most years, ROIC significantly increased in 2024, and it is expected that the company will continue to achieve positive ROIC going forward. The company also delivered its highest free cash flow ever in 2024, and management expects free cash flow generation to meaningfully exceed 2024 levels in the future. Competition is a significant risk for Spotify because it faces powerful global rivals like Apple, Alphabet, Amazon, Meta, and ByteDance, all of which have broader ecosystems, stronger brands, and greater financial resources, making it harder for Spotify to attract users and advertisers. Structural disadvantages such as app store control, bundled service offerings, and intense competition for ad budgets further pressure Spotify. Music licensing and royalty costs are another major structural risk because royalties to record labels, artists, and publishers consume around 70% of revenue, capping gross margins and limiting profitability even as the user base grows. Macroeconomic conditions also pose a risk because economic downturns can reduce advertising spending and discretionary consumer purchases, directly impacting both Spotify’s ad revenue and subscriber growth. On the opportunity side, expanding into new products like podcasts, audiobooks, video podcasts, and educational content offers Spotify important long-term growth opportunities by deepening user engagement, diversifying revenue streams, and improving margins. Advertising is another major growth driver as Spotify transitions to automated, programmatic ad sales, making its large and engaged audience more accessible to advertisers through platforms like The Trade Desk. Combined with Spotify’s powerful consumer data and expanding video inventory, this shift positions the company to capture a larger share of the growing global advertising market while improving monetization efficiency. Emerging markets also offer significant long-term growth potential for Spotify, with strong user engagement and subscriber momentum already visible in regions like Latin America, India, and Southeast Asia. As these economies mature and consumer spending power rises, Spotify is well-positioned to expand its user base and build future revenue streams from large, young populations. Overall, I believe there are many things to like about Spotify, and buying shares at $277, which represents a 25% discount to the intrinsic value based on the Payback Time price, would be a good long-term investment.

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