Spotify Shares Rally on Strong Outlook. Can the Stock's Momentum Continue?

Shares of Spotify (NYSE: SPOT) jumped after the music subscription service reported strong Q4 results and issued upbeat Q1 guidance. Despite the stock price jumping nearly 15% in the trading session following its earnings report's release on Feb. 10, it is still down around 18% year to date, as of this writing.

The stock was under pressure earlier this year on fears of gross margin compression and the potential for user growth to slow. However, neither of those concerns showed up in its results or guidance.

Let's take a closer look at the company's results and prospects to see if the stock can continue to rebound.

Image source: Getty Images.

Growing users and increased prices

Spotify announced earlier this year that it was raising its premium subscription prices in the U.S. from $11.99 a month to $12.99 a month starting in February. While the move could have impacted its premium subscriber numbers, the company projected 3 million net new premium subscriber additions for Q1 to 293 million. It projected total subscribers to rise to 759 million for Q1, which was above analyst estimates of 752.45 million users, as compiled by Bloomberg.

Meanwhile, the company forecast that its Q1 operating income would climb to 660 million euros ($785 million), above analyst estimates of 645 million euros ($768 million). Gross margin guidance of 32.8% also came in above expectations of 32.2%. It guided for revenue of 4.5 billion euros ($5.35 billion), just shy of the 4.58 billion consensus ($5.45 billion).

For Q4, its revenue rose 7%, or 13% in constant currencies, to 4.53 billion euros ($5.39 billion). Its premium revenue climbed 8%, or 14% in constant currencies, to 4.01 billion euros ($477 billion), while ad-supported revenue fell 4% to 518 million euros ($616 million), but was up 4% in constant currencies.

Gross margin expanded 110 basis points to 33.1%. Premium gross margins edged up 10 basis points to 34.8%, while ad-supported gross margins jumped 441 basis points to 19.5%. Operating income, meanwhile, surged 47% to 701 million euros ($834 million).

The company said it plans to invest heavily in artificial intelligence (AI) to increase personalization and enhance the user experience. It is also looking to expand beyond music into both audiobooks and physical books to become a complete media platform. It's also moved to a new proprietary ad stack and expects to see strong ad growth as a result.

Can the stock keep its momentum up?

Spotify's results and guidance helped dispel the worry that the company was going to see margin compression or that its premium user growth would be impacted by recent price increases. That said, the stock is not cheap even after this year's pullback, trading at a forward price-to-earnings ratio (P/E) of 33 times 2026 estimates.

While Spotify has become an integral part of the music industry through its scale, I think the stock's valuation likely limits its upside given its current growth. As such, I would not chase this post-earnings rally.

Geoffrey Seiler has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Spotify Technology. The Motley Fool has a disclosure policy.