Although not as famous as Warren Buffett, Peter Lynch has established himself as one of the most successful investors in the world. From 1977 to 1990, his fund made a compounded annual return of 29.2%, making it the world’s best-performing fund during this time. Lynch has also provided a lot of investment advice, including recommendations to “buy what you know” and “invest for the long term”. But one of my personal favourites is his insider trading quote. This stated that “insiders might sell their shares for any number of reasons, but they buy them for only one: they think the price will rise”. I would use this advice to buy Spotify (NYSE: SPOT), which has seen significant amounts of insider buying recently. This is despite the downturn in growth stocks over the past few months.
Who has been buying?
At the start of the May, it was announced that Daniel Ek was pouring $50m into Spotify shares. There are two reasons why this is a big deal. Firstly, investing $50m is a big sign of confidence into a company and cannot be considered merely tokenistic. Secondly, Daniel Ek is the co-founder of Spotify and the CEO. This means that he has significant amounts of inside knowledge around the company. In a period where growth stocks are getting considerably beaten down, this shows that he genuinely expects the Spotify share price to rise. It is also a fundamental reason why I am tempted to buy some shares in the company.
Despite this insider buying, the Spotify share price has continued to slip. In fact, it is currently priced at $99. This is lower than when Ek recently bought shares and a 60% decline from last year. Such a fall has mainly been caused by the general sell-off of growth stocks, alongside worries about the firm’s profitability.
For example, in Q1, despite revenues reaching €2.6bn, gross profit only totalled €671m. This means that gross margins only equal 25%. Other streaming services, such as Netflix, operate with gross margins of over 40%. This highlights that Spotify has extremely low margins for the streaming industry. As these large expenditures are not likely to decrease, this raises concerns about the ability for Spotify to ramp up its profitability.
Why would I still buy this growth stock?
Despite these concerns, I am still confident about the future of Spotify. In the recent investor day, Ek reiterated plans for the company to “get a billion users”, while also generating $100bn in annual revenue and 40% gross margins. These targets are very ambitious. Yet if they can be achieved, it is likely that the Spotify share price would soar in the long term.
Further, the group currently trades at a price-to-sales ratio of under 2. Yet in Q1, revenues grew at a rate of 24% year-on-year. This indicates that the Spotify share price may have now dipped too low. Therefore, although I worry about the current poor gross margins, I still believe this growth stock has been overly beaten down. Daniel Ek’s recent purchase equally provides me with optimism. Therefore, I am tempted to add some Spotify shares to my portfolio.