Mark Zuckerberg, the founder of Facebook and CEO of Meta Platforms (META 0.58%), has clearly expressed his vision to pivot his company into the metaverse. While no one knows how successful this endeavor will be, the way he has directed his company's spending makes it clear Meta Platforms is going all in.
This decision has had dire consequences, as the stock has plummeted nearly 50% from its all-time high. However, Meta Platforms still has a thriving advertisement business on its key platforms, like Facebook and Instagram. Is the stock doomed? Or is the market undervaluing its core business?
Excessive spending is costing Meta Platforms
Meta Platforms made headlines during the fourth quarter of 2021 when it reported that Facebook daily active users (DAUs) had declined for the first time on record. But, Facebook recovered in Q1 and reported the most DAUs in the company's history.
By stopping its user loss, Facebook can focus on its advertising revenue. Overall, Meta brought in $27.9 billion in revenue, up 7% year over year. However, this growth didn't reach the bottom line, as total costs and expenses rose 31% over the prior year.
The culprit? Its Reality Labs division. According to Meta, this segment includes augmented and virtual reality hardware, software, and content and is in the early stages of development. Creating groundbreaking technology isn't cheap, and Reality Labs lost $3 billion from operations versus the mere $700 million it brought in.
Compared to its advertising revenue of $27 billion and an $11 billion operational profit, the Reality Labs division is putting a drag on Meta's financials.
In Meta Platform's earnings call, Zuckerberg commented on this and said he wants the "family of apps to fund the growth of investment in Reality Labs, while still growing our overall profitability." He went on to say this won't happen in 2022, but beyond that, he believes Meta can accomplish its goal of increasing its advertisement profitability while strengthening its Reality Labs segment.
Although this is a great aspiration to have, is it feasible? Net income fell 21% year over year, so Meta will need to recover $2 billion in profits to produce flat growth. For Meta to get back to producing more robust cash flows, it will need to cut its spending -- something management is already doing.
Instead of the $90 to $95 billion it was expecting to spend during 2022, Meta will cut back and spend only $87 to $92 billion. For reference, Meta spent $71 and $53 billion in 2021 and 2020, respectively. Even though this spending cut is a nice gesture, it's nowhere near the amount necessary to return it to its pre-metaverse profitability.
The stock is cheaply valued, but it has plenty of risks
Because of all this negative commentary, the stock has sold off hard. Yet, when assessed on its price-to-earnings (PE) ratio, Meta Platforms looks tempting.
Its forward PE ratio is greater than its trailing ratio because earnings are expected to fall later in the year, lowering the ratio's denominator. Still, even at 17 times earnings, Meta is valued cheaper than Home Depot (18) and Coca-Cola (26). These are very stable companies, with slow but consistent growth in front of them. Meta expects to return to average growth after revenue headwinds caused by privacy changes are behind it. However, Meta's average growth is a lot quicker than Home Depot or Coca-Cola's.
The stock market is examining Meta with an extremely short-sighted mindset. If you have an investment horizon of three to five years (as nearly all investors should have), then Meta Platforms is a bargain. Should one of its Reality Labs products change the world, it would be the jolt this company needs to continue funding its ambitions.
This isn't to say Meta is a risk-free investment, as it has its dangers. Roughly all of its revenue is derived from advertising -- an area that has historically done terribly during a recession. With GDP falling 1.4% during Q1, the U.S. is technically halfway to a recession. But, with about 5 million more job openings than unemployed people, the hypothetical recession's intensity may not be enough to affect the top advertising players.
Meta Platforms has huge ambitions in the metaverse; it just can't forget its shareholders along the way. The stock has risks, but its valuation and platform dominance makes today an excellent time to get into a stock with great long-term potential.