In this article, I present why I hold a bullish position on Netflix (NASDAQ:NFLX), a market leader in the subscription streaming space, while maintaining a neutral outlook on Spotify (NYSE:SPOT), another key player in the sector.
Despite differing business models and market caps, NFLX and SPOT have performed similarly over the last five years, delivering significant returns despite drawdowns, particularly in the last two years. However, I believe Netflix is better positioned than Spotify currently due to its superior profit margins, successful diversification of revenue streams, and strong strategic moves that I will highlight below. Let’s dive in.
Same Industry, Different Business Models
Before comparing the two stocks, it’s crucial to note that while both operate in the streaming space, they do so in entirely different ways. Netflix initially focused on licensing content and gradually built up its platform. Now, it emphasizes producing original content to set itself apart from competitors.
Conversely, Spotify operates in the audio streaming market and cannot easily create its own content. Instead, the company must pay music and podcast licensors to host their productions on its platform. Spotify’s business model relies heavily on its relationships with record labels and its ability to negotiate favorable licensing deals.
Despite these differences, both companies generate revenue primarily from recurring monthly subscription fees. Additionally, Spotify earns ad revenue from its free plan. Netflix announced its ad-supported subscription plan late last year, which has shown promising progress but is still in its early stages.
Each model has its pros and cons. Netflix relies more heavily on subscription-based revenue, which may not be sustainable in the long term due to the high cost of content creation. On the other hand, Spotify’s business model hasn’t allowed the company to control fixed costs, as more streams also entail higher licensing expenses—unlike Netflix, where in-house productions become more profitable with increased subscriber attraction.
Competitive Landscape in the Streaming Industry
The streaming space is fiercely competitive, with services experiencing rapid growth, especially since the COVID-19 pandemic accelerated the shift to online streaming.
Media companies are vying for streaming subscriber growth, driving up content costs. This competition has prompted companies like Amazon (NASDAQ:AMZN) and Apple (NASDAQ:AAPL) to invest billions in their video and audio streaming services, often at a loss.
Despite increasing competition, Netflix continues to dominate the video streaming market, even as one of the most expensive services among its main competitors. Data from the beginning of 2024 indicates that Netflix holds the second-largest market share, following only YouTube (which largely relies on ads), with 7.9% compared to YouTube’s 8.6%. Close behind are PrimeVideo, Hulu, and Disney+, with market shares of 2.8%, 2.7%, and 1.9%, respectively. For comparison, in January 2022, Netflix held a market share of just 6.6%.
Similarly, Spotify holds a dominant market share in the music streaming market, currently around 31.3%, more than double that of second-placed Tencent Music (NYSE:TME). However, its market share has been gradually declining. In the second quarter of 2019, for instance, Spotify held 34% of the music streaming space market share.
Growth Trends and Valuation
Comparing the revenue growth over the last three years, Netflix achieved a compound annual growth rate (CAGR) of 9.8%, while Spotify’s CAGR stood at 19%. This indicates a much stronger growth trend for the leading company in the music streaming market. However, a significant difference between the two lies in their profit margins.
In Q1 2024, Netflix reported gross profit margins of 46%, whereas Spotify’s is much lower at 28%—relatively low for a big tech company reliant on recurring service revenue. When considering operating margins, Netflix’s 28% outperforms Spotify’s margin of 4.6%, indicating that the video streaming giant is better positioned and more consolidated in terms of profitability.
While there’s an expectation for Spotify to report an annual profit in 2024, the company is anticipated to trade at a stretched forward price-to-earnings (P/E) ratio of 65x. Considering solely revenue generation, Spotify currently trades at a price-to-sales (P/S) ratio of 4x, compared to Netflix’s 8x. This discount on the multiple appears justified considering the disparity in their business models, with Spotify yet to prove sustainability.
Is NFLX Stock a Buy, According to Analysts?
Wedbush analyst Alicia Reese, who maintains a Buy rating on Netflix, justifies the stock’s premium valuation compared to peers by highlighting strategic moves the company has made to diversify revenues. These include enhanced ad solutions, expanded partnerships, and the addition of live events, all expected to significantly boost ad-tier revenues. Alongside cost management efforts and scaling up profitability, these initiatives are anticipated to lead to increased free cash flows.
On Wall Street, Netflix currently holds a Moderate Buy consensus, with 23 out of 36 analysts covering the stock recommending a Buy. 12 analysts rate it a Hold, and one rates it a Sell. The average NFLX stock price target is $657.98 per share, implying 1.7% downside potential.
Is SPOT Stock a Buy, According to Analysts?
For Spotify, recent decisions such as raising subscription prices in the U.S. and implementing cost reduction measures, including staff layoffs, are seen as steps toward sustained margin improvement. This is according to analyst Maria Ripps from Canaccord Genuity, who also maintains a Buy recommendation on SPOT.
The analyst consensus for Spotify is a Moderate Buy, with 19 out of 26 analysts recommending a Buy and seven recommending a Hold. The average SPOT stock price target is $353.39 per share, suggesting upside potential of 12.9%.
The Verdict
Netflix and Spotify, both dominant players in the streaming space, operate in different segments—video and music, respectively—and rely primarily on subscriber revenue, yet their business models diverge significantly.
Although Netflix is more closely surrounded by competition, the company has successfully maintained robust margins and continues to exhibit strong revenue growth trends. However, investors must be willing to pay a premium valuation for this.
Despite its substantial lead in music streaming, Spotify has faced challenges with margins. While the company has made notable progress in recent quarters, profitability has yet to be achieved. Its thin margins for a recurring subscription model are affected by increased licensing expenses as it offers more streams. Conversely, Netflix achieves high profit margins with its in-house productions.
Therefore, even though Spotify trades at a P/S ratio almost half that of Netflix, I view the video streaming giant as a much more solid and sustainable business. Thus, I believe that NFLX is currently a better option between the two.
