The Nasdaq Composite is full of high-growth companies, many of which fall under the technology sector umbrella. The index is down nearly 26% since the start of the year in light of major changes to the macroeconomic landscape: sky-high inflation, higher borrowing costs, and geopolitical concerns. None of those have boded well for tech stocks of late, triggering a sharp shift to safer investments like value stocks and fixed-income instruments.
At the top of the list of beaten-down tech stocks is social media juggernaut Meta Platforms (META 0.03%). Mark Zuckerberg's business has shed 55% of its market capitalization year to date, erasing all gains the stock had made over the past five years. Is it time to double down on the social media giant, or is there too much going on at the moment to suggest it's a good investment today?
Let's look at its current situation to try and answer that question.
Image source: Getty Images.
The problems facing Meta Platforms
Meta Platforms, formerly Facebook, is facing a two-headed monster at the moment: a flagging digital advertising environment, and its own money-losing Reality Labs division.
The lion's share of Meta's revenue comes from digital advertising, a market that has been hit hard by the darkening economic outlook. In its most recent quarter, advertising sales had a rare year-over-year decline, falling 1.5% to finish at $28.2 billion -- which accounts for almost 98% of total company sales. For context, in the same quarter last year, Meta's advertising revenue soared by 56%. So the social media behemoth has a problem with its core revenue stream.
And then there's its Reality Labs business, the company's metaverse segment, which focuses on virtual reality (VR) and augmented reality (AR) hardware and software. It's exerting pressure on Meta's margins and profitability. In the second quarter, Reality Labs generated $452 million in sales, a robust 48% increase year over year. But there's one major caveat -- Meta is losing more than six times as much money from Reality Labs as it's making. In the second quarter, the segment suffered an operating loss of $2.8 billion, greater than the $2.4 billion loss in the same quarter last year. And it's aggressively ramping up spending, with its research and development costs soaring by 43% in Q2 to $8.7 billion.
Zuckerberg is placing a lot of his chips on the future of the metaverse. But for the time being, Meta's margins will suffer the consequences.
How will the social media giant respond?
The curtailment of Meta's ad revenue is not a one-off situation. Other businesses like Snap and Alphabet are being adversely impacted as well. After all, digital advertising is cyclical -- during economic downturns, companies have to cut their budgets, and one of the first areas they tone down is advertising. Sure, Meta is also facing ad-related challenges connected to Apple's iOS privacy changes, but by and large, the slowdown in ad revenue is quite natural.
In regards to Reality Labs, nobody knows whether the social media giant's aggressive investments will pay out in the long run. The future of the metaverse looks bright, but there's certainly a great deal of risk associated with the company's ongoing transition. That said, I'm not all that worried given Meta's $40.5 billion in cash and marketable securities, and a core business that has 3.7 billion monthly active users (MAUs) in its network. I wouldn't hit the panic button yet; the company is still extremely well positioned for future success.
Is now the right time to buy Meta Platforms?
With a softening digital advertising environment and its grand metaverse transformation, Meta Platforms has a lot to work through at the moment. But I like to take a long-term approach, and it's difficult to imagine the social media company not bouncing back strongly given its MAUs and cash hoard.
And then there's its price-to-earnings (P/E) multiple, currently around 12.5 -- a long way short of its historical levels. Between 2017 and 2021, Meta averaged a P/E ratio of 27.9. Note that the current price-to-earnings multiple of the broader S&P 500 index is 20.6, so the world-leading social media firm is trading at a discount to the overall market. I believe its present valuation gives investors a wonderful margin of safety.
Keep in mind, however, that Meta's growth is currently nowhere near where it has been over the past five years, and competition in the digital advertising arena has become much more intense. If that doesn't give investors a reason to worry about the stock, then its capital-intensive metaverse business surely does. There's no doubt that we're dealing with a much different business today, which is probably why its valuation has taken such a massive hit. But while we need to be wary of its fierce competition and ambiguous metaverse transformation, it's also vital to remember that Meta is extensively profitable, cash-flow positive, and enjoys the most monthly users of any social media business in the world. I understand investors' concerns, but I think the sell-off has been overdone.
It might be a bumpy ride for the social media titan in the immediate term, but the company should boomerang back over the long run.
