3 Reasons To Avoid Spotify Stock

1. The stock is currently overvalued.

Tech IPO's have recently had a bit of a hard time getting off the ground, and this trend is sure to continue with a company like Spotify. The current valuation has Spotify coming in at about $24 billion, which is difficult to justify given the company's current financial state. Spotify is very far away from making a profit, and there are a lot of questions about the sustainability of their business.

This is unlike Netflix, where shares were trading at a premium to actual earnings because of pure potential. Netflix developed a way to take out major players in their industry and take market share away from them. Spotify developed during an age where the transition out of traditional media was already happening, and there aren't giant record stores to take market share away from. They already have a large user base, are far away from turning a profit, and will continue to face pressure to increase the amount that they pay artists for their streams.

2. Insiders are already selling.

This might be the most important evidence that the shares are currently overvalued and that those who know the business are looking to cash in on their investments. Sony recently sold over 17% of its shares on the first day of trading. No one sells equity that they believe is going to go higher, especially on the first day of trading.

We wouldn't put all of our weight into this analysis, as you could guess Blockbuster didn't believe Netflix was worth much long-term when it first started out. However, when you take all of the available information together, it's hard to justify the current valuation. More insider selling would certainly send the stock lower.

Look at how quickly the stock sold off as soon as it IPO'd. Scary, scary stuff.

Look at how quickly the stock sold off as soon as it IPO'd. Scary, scary stuff.

3. The long-term horizon of streaming is still extremely murky.

In order to increase profitability, Spotify needs to own the content it is distributing to its membership. This will not only get it away from licensing music from labels, where they have a most favored nations deal and are unable to negotiate differently with separate labels, but it will also allow them to offer exclusive content a la Netflix's model.

This is the path to profitability, and Netflix has utilized it to near perfection in order to become the powerhouse that they are. But again, this is not an apples to apples comparison. There are several strong competitors to Spotify currently. While I'd say that Spotify is a strong leader, Apple has the cash and the leverage necessary to compete and slow growth. There are also other players like Pandora that demonstrate that making money in this business isn't as easy as it seems, and Tidal had a hard time getting off the ground even with the support of major artists and exclusive content. 

At a lower evaluation, we wouldn't mind taking a closer look at Spotify, but at current prices, it's difficult for us to justify this share price. We say stay away for now.