Meta Platforms Reports First-Ever Revenue Drop. Should You Sell The Stock?

Facebook parent Meta Platforms (META 0.14%) has been a growth stock juggernaut. It's gone from a start-up founded by a teenager in a Harvard dorm room to a digital advertising behemoth that was worth more than $1 trillion at one point.

However, Meta's growth story is cracking right in front of us. For the first time ever, the company reported a quarterly decline in revenue in its Wednesday earnings report. In the second quarter, the top line slipped 0.9% to $28.82 billion, just shy of analyst expectations at $28.94 billion. On a constant currency basis, revenue would have increased 3% as the stronger dollar added to the headwinds.

Profits fell sharply in the quarter as the company continued to invest in new products like Instagram Reels and Reality Labs, its virtual reality division, and earnings per share dipped from $3.61 to $2.46, missing estimates at $2.61. The stock finished Wednesday's after-hours session down 4.7%

Even worse, the company said it expects the revenue slide to accelerate in the current quarter, calling for $26 billion to $28.5 billion in revenue, a sequential decline and a drop of 6% at the midpoint from the third quarter 2021. Adjusting for currency exchange, revenue growth is expected to be flat in Q3.

User growth was also sluggish with active users only inching up from the previous quarter and Facebook monthly active users actually falling from the first quarter. That's a sign the company has little growth left from its user base, which has reached roughly 3.65 billion by its broadest measure, about half the world's population.

Trouble on all sides

The company is getting hit on multiple fronts by macro-level challenges, changes in the competitive landscape, increased regulatory burdens, and its own questionable business decisions.

Perhaps the biggest reason Meta's revenue growth has become negative is competition from TikTok. Though management rarely mentions TikTok by name, the video-based app's rapid growth has sent shockwaves through the social media industry. TikTok has gobbled market share from other social media giants with its user base climbing past 1 billion last year, achieving that milestone much faster than either Facebook or Instagram did.

Meta has doubled down on Instagram Reels, its TikTok-copycat product, but that strategy has elicited complaints from users, including celebrities Kylie Jenner and Kim Kardashian, who want Instagram to stay true to its core photo-sharing identity.  

That backlash underscores the challenge Meta faces as it tries to ape TikTok. It can't be all things to all people, and loyal Facebook and Instagram users come to the platform for the core functions they've always had. In some ways, Meta has gone from being the disruptor to being disrupted, and in keeping up with TikTok, it now faces the same innovator's dilemma that other legacy media companies have struggled with in the past. 

Further, Apple's ad targeting changes continue to be a headwind for Meta as they are for the rest of the social media industry. And Regulators are pressuring the company too. Yesterday, the Federal Trade Commission announced a lawsuit to block Meta's acquisition of Within, a virtual reality fitness app. Meanwhile, Ireland's data watchdog said earlier this month that it would block Meta from sending user data from Europe to the U.S. Negotiations over data transfer policies between the European Union and the U.S. are ongoing, but the proposed crackdown is severe enough that Meta has threatened to shut down its business in Europe, the source of more than 20% of its ad revenue.  

Macro headwinds related to inflation, a slowdown in e-commerce spending, and fears of a recession have also weighed on Meta's performance as they have for peers like Snap and Alphabet's Google. Slowing growth has led the company to scale back hiring and investments.

The company's big bet on the metaverse also seems increasingly questionable. Revenue in its Reality Labs segment grew 48% to $452 million in the quarter, but it posted an operating loss of $2.8 billion in the metaverse division. Worse, management said it expected Reality Labs revenue to decline sequentially in the third quarter, a sign its Quest VR headsets aren't gaining traction as hoped.

Should you sell Meta stock now?

There is a parade of reasons to avoid buying Meta stock right now, and the challenges the company is facing are borne out in the declining revenue and profits.

But there is a silver lining here: The market had largely anticipated these results. Had it not, the stock would have fallen much more than 5% on yesterday's news. In fact, investors have been skeptical of the social media giant for a while, as it's traded at a modest price-to-earnings (P/E) ratio for years. Even after the second-quarter report, its price-to-earnings ratio is just 14, which puts Meta on par with no-growth legacy tech firms like IBM and is significantly cheaper than the S&P 500's P/E ratio at 20.3, meaning Meta stock now trades like a value stock rather than a growth stock. 

That seems mispriced. Though Meta Platforms is going through one of the most challenging periods in its history, the company has a number of evident competitive advantages and should be able to return to modest growth as it builds out its ad product for Reels and as macro and industry-level headwinds fade.

It seems too soon sell Meta stock if it's in your portfolio, especially given the valuation. But the stock does deserve some time in the penalty box, with investors avoiding picking up new shares. If Meta can't overcome at least some of the challenges above and return to stable revenue growth in the next year, it might be time to click the "unfriend" button and drop it from your portfolio.