This beat stock could be music to investors’ ears

Music is part of our daily life. With the rise of the Internet, cell phones and music streaming services, billions of people around the world now have the ability to listen to millions of songs at the touch of a button. This trend has led the music industry to rebound after declining in the early 2000s due to the prevalence of pirated content.

For companies that own the rights to these songs, such as music labels, this proved to be a huge opportunity. An example is Warner Music Group (WMG -1.62%), which has popular artists like Ed Sheeran and the Red Hot Chilli Peppers under contract. The company stands to benefit from the boom in music streaming this decade.

However, the stock is down 37% year-to-date (YTD), likely due to the high volatility we are currently experiencing. This price drop may present a buying opportunity for long-term investors. Here’s why.

What is a music label?

Warner Music Group, or WMG, describes itself as a “great music company”. It’s not very helpful in understanding how the business works, so let’s dig a little deeper. WMG is a conglomeration of different music labels. Music labels recruit and sign contract musicians, allowing WMG to earn a royalty stream on all the money they make. In return, artists receive upfront payments, distribution management on internet platforms such as Spotify, marketing benefits and other services. It works (theoretically) in a symbiotic way in which the artist and the label enhance each other.

As one of the oldest music labels, WMG has been able to maintain its market share of recorded music revenue over the past few decades. In 2020, the company was estimated to hold 16% market share. Since 2006, this market share has been around 14% to 18%, which shows the durability of WMG’s position within the industry.

Streaming and digital, growth engine

As mentioned above, the music industry went through a tough time with pirated music in the early days of the internet. But with the rise of music streaming, that all changed. From fiscal 2018 to 2021, WMG’s digital revenue grew at a compound annual growth rate (CAGR) of 16.5%, reaching $3.5 billion in revenue last year.

The segment currently accounts for 67% of WMG’s overall revenue and is expected to be the company’s main growth driver in the future. According to third-party analysts, music streaming is expected to grow at a CAGR of 14.6% through 2030. If WMG can maintain its market share, this should translate directly into revenue growth.

In addition to streaming, WMG is seeing strong growth from other internet outlets, including places like TikTok, Metaplatformsand Platoon. He just signed a deal with Meta (owner of Facebook and Instagram) that management says will generate significant licensing revenue starting this quarter. While not as big as the streaming segment, these other licensing deals are a nice icing on the cake for WMG to make more money for itself and the artists it manages.

But what about valuation?

With the current stock drop, WMG is trading at a market capitalization of around $14 billion. Over the past 12 months, it has generated an operating profit of $650 million, giving it a price-to-operating earnings (P/O) ratio of 21.5. It’s just around the market average. What you should take away from this as an investor is that if WMG can continue to grow revenue and operating profit by around 10-15% per year, the stock price should follow suit. Over a long enough time horizon, this can result in handsome gains for your portfolio.

WMG operating profit (TTM) given by Y-Charts.

If you believe in the continued growth of music streaming around the world, WMG could be a great stock to bet on. At current prices, the stock is also not trading at a higher valuation.

Randi Zuckerberg, former director of market development and spokesperson for Facebook and sister of Meta Platforms CEO Mark Zuckerberg, is a board member of The Motley Fool. Brett Schaefer holds positions in Spotify Technology. The Motley Fool holds posts and recommends Meta Platforms, Inc., Peloton Interactive, and Spotify Technology. The Motley Fool has a disclosure policy.

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