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September 01, 2020 1:41pm
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Stocks With Subscription Based Revenue Offer Inflation Protection

Investors should be amazed at where consumer priorities lie regarding monthly payments. Besides ensuring the mortgage and car are paid, consumers will likely emphasize subscriptions. The evidence behind this belief? Financial stocks like Bank of America reported rising delinquency rates on credit cards with declining FICO scores. At the same time, companies like Netflix Inc. (NASDAQ: NFLX) saw 16% growth in global paid memberships. 

Despite the U.S. economy suffering from stagflation, defined as low economic growth with high inflation, consumers still find a way to fit these subscriptions into their budgets. Because of this tendency, investors could consider such businesses part of the consumer staples sector rather than the consumer discretionary group.

Knowing that consumers will likely keep paying for their subscription memberships, investors highly value revenue for such businesses, especially amid an uncertain economic environment. Stocks like Spotify Technology (NYSE: SPOT), T-Mobile US Inc. (NASDAQ: TMUS), and even Netflix could prove outperformers in the coming quarter.

Inflation Protection? Yes Please

Subscription-based businesses not only achieve predictable cash flows, making them easier to value for Wall Street analysts and more attractive for investors, but they are also able to quickly shrug off the effects of high inflation by raising prices across the board. 

With 269.6 million global subscribers, Netflix could raise prices by $1 and immediately add nearly $270 million to the top line. Likewise, Spotify’s 239 million users could have the same effect on the company’s financials, especially knowing users will try to avoid the pain of vibe-cutting advertisements. 

Whether the economy is booming or busting, people will likely always find a way to pay their phone bill because consumers won’t be able to prospect for jobs without a phone (in the case of a bad economy).

With 119 million users as of the fourth quarter of 2023, T-Mobile could justify a few extra million in revenue by merely keeping up with inflation. 

All three of these stocks can protect their investors from inflation just by raising monthly subscriptions to their users. Because of the quality and reliability of these revenues, markets are willing to pay a premium valuation for these stocks, measured on a price-to-sales (P/S) basis. 

It’s All About Growth, Steady Growth

Compared to its peers in the communication industry, T-Mobile stock commands a premium of 50% through its 2.4x P/S versus the sector’s 1.6x average.

Spotify follows suit by trading at a 3.9x multiple, which is 290% above the radio and broadcasting industry’s average P/S valuation of 1.0x. Last but not least, investors can see this trend in Netflix’s 7.9x P/S multiple, which is 192% above the streaming industry’s 2.7x.

Markets value these companies at a premium for their steady revenue sources and their future expected growth rates. Based on an earnings per share (EPS) basis, analysts believe Netflix's stock could deliver up to 21.2% growth in the next 12 months. 

Spotify could be set to deliver 41.4% EPS growth this year, which gives investors a leg up above inflation in the U.S. and ensures that this potential investment could outperform the nation's lackluster GDP growth of 1.6% in the past quarter.

In another double-digit growth clip, T-Mobile expects to deliver 24.8% EPS growth despite the inflation-choked U.S. consumer. 

Consumer sentiment declined in April, bringing the index halfway to its all-time low. However, consumers still find enough reasons to keep these companies flowing with steady cash flows, which is why Wall Street keeps them in high regard.

Wall Street’s Take

Spotify shares trade at 91% of their 52-week high, showing investors that bullish momentum still rules the media company. Analysts at Bank of America see a valuation for Spotify up to $370 a share, calling for as much as 27.5% upside from where the stock trades today. 

The optimism spills over to Netflix now that the stock has pushed back up to 96% of its 52-week high after a recent earnings hiccup. Recovering its bullish beat, the stock earned an $800 price target from Pivotal Research. To prove these valuations right, the stock must rally 30.5% from where it sits today.

Who knew phones could be this exciting? Analysts at TD Cowen see a valuation of $202 for T-Mobile stock, or 25% upside from today’s price. Of course, trading at 96% of its 52-week high helped analysts feel more comfortable backing this winner. 

The one theme investors need to focus on is predictable revenue; analysts and markets aren’t afraid to bid companies like these up, particularly since nothing else is lining up to beat stagflation.

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