Double-Digit Profits May Be in Store With This Peter-Lynch-Style Pick

One of my financial heroes is Peter Lynch. He managed the Fidelity Magellan Fund from 1977 to 1990, returning an astounding average 29% per year during his tenure. 

Lynch’s investing mantra is so simple some may overlook its power: “Buy what you know.”

The strategy of investing in companies you are familiar with and understand can give you a leg up in the market. If you like a particular brand, service, product or company, it’s likely others do as well. This should attract buyers to the company’s shares, driving up the stock price.

This simple-but-powerful idea is what led me to today’s stock pick, Pandora Media (NYSE: P).

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I love all types of music — from the blues to classical, ambient to heavy metal. Pandora has become my go-to source for daily listening. The streaming music service has incredible depth and breadth across all genres.

Most importantly, Pandora builds custom listening experiences for users based on the songs, artists or genres they enter. This truly amazing technology, based on the company’s Music Genome Project, breaks music down by melody, harmony, instrumentation, rhythm, vocal style, lyrics, etc., to anticipate what listeners will enjoy. 

Perhaps the best part for users is that the service is completely free. For those who want an advertising-free listening experience, the company charges a modest $4.99 monthly fee. Over 250 million registered users and 77 million active listeners have helped propel the company to a market cap of $6.11 billion. 

In the most recently reported quarter, total revenue increased 69% year over year to $194.3 million. Advertising revenue jumped 45% to $140.6 million, while subscription and other revenue surged 94% to $39.5 million (excluding $14.2 million in revenue relating to its subscription return reserve). 

Listener hours increased 12% over the same period last year to 4.8 billion. And ad revenue per thousand listener hours increased 50% year over year to $40.51 million.

However, despite this growth, Pandora remains in negative territory with profit margins, EBITDA and diluted EPS.

In an effort to reverse this, the company is focusing on local ad revenue by deploying a boots-on-the-ground salesforce in 37 markets with a goal of expanding to 239 markets. This localization of advertisers — in other words, targeting listeners’ exact areas — should work to dramatically increase the company’s bottom line.  

In addition, Pandora is increasingly being integrated into the automobile industry as an in-car entertainment choice. Available as a built-in feature in 130 car models and in hundreds of aftermarket devices, the company has 5 million auto users. 

Management forecasts revenue will increase more than 30% to $213 million to $218 million in the current quarter. Diluted EPS is expected to be between $0 and $0.03.

Analysts are mostly neutral to bullish on the stock. MKM Partners, which recently upgraded shares from “neutral” to “buy,” has a $35 price target and said P could be worth up to $115 in five years. Canaccord Genuity analysts have a “buy” rating with a $43 target.  

Competition from the likes of Spotify, iHeartRadio, Amazon.com (NASDAQ: AMZN), Google (NASDAQ: GOOGL) and Apple (NASDAQ: AAPL) is no doubt fierce. Some analysts see this as a potential company killer in the long haul, but I see things differently.  

Pandora is the pioneer in the music streaming space, and with its Music Genome Project technology and adeptness at capturing advertising dollars, it’s quite possible a big tech company could make an offer it can’t refuse. Speculating a bit, a bidding war could easily push P into the stratosphere.

Even without a buyout, the negative metrics should soon be reversed if Pandora remains on the current growth trajectory.

Recommended Trade Setup:

— Buy P at the market price
— Set stop-loss at $27.90
— Set initial price target at $36 for a potential 22% gain in 90 days