Standard valuation metrics like the price-to-earnings (P/E) ratio and the price-to-free-cash-flow (P/FCF) ratio are useful when the future of a company is at least somewhat predictable. How much free cash flow will Procter & Gamble produce 10 years from now? Using the current value and the historical growth rate, you can come up with a reasonable estimate that will probably be in the ballpark.
Meta Platforms (META -1.46%), the company behind Facebook, Instagram, and the money pit it calls the metaverse, does not fall into this category. The range of potential outcomes is so vast that valuation metrics are completely meaningless. Investing in the company is a pure leap of faith.
Looking at it the wrong way
If you looked at Meta stock last year, you might have been fooled into thinking it was incredibly cheap despite a trillion-dollar valuation. Revenue soared 37% in 2021 to $118 billion, and both net income and free cash flow were right around $39 billion. For a dominant company growing that quickly, a P/E ratio of 25 probably seemed pessimistic.
Meta is made up of two parts: the core advertising business, which monetizes the billions of users of its family of apps, and the metaverse business, which is the company's moonshot. The bull case for Meta involves viewing the company as a stable, growing, highly profitable advertising business plus a wild card that could one day dwarf that advertising business. Even if the metaverse turns out to be nothing, you've still got that advertising business.
This is the wrong way to look at the company, in my opinion. I view Meta as two wild cards smashed together. The advertising business is far from stable, as we've learned this year, and it's dependent on the continued popularity of social media apps that are losing their luster with younger users. Less than one-third of U.S teenagers use Facebook, according to a Pew Research Center study. Instagram is more popular, but it's been surpassed by TikTok and is at risk of suffering the same fate as Facebook.
Acquisitions are probably off the table; there's no way regulators would allow Meta to snap up another social media app. That leaves Meta with social media apps that are likely past their prime, with the added weight of suffering the consequences of the changes Apple made to privacy in iOS that reduces the effectiveness of ads on Meta's platforms.
Meta's revenue slumped 1% in the second quarter, and net income plunged 36%. The company boosted the number of ad impressions by 15%, but the average price per ad tumbled 14%. Hurling more ads at its users will only give them more reasons to abandon the company's platforms. This strategy will work until it doesn't.
The advertising business could remain a cash machine for decades, or it could shrivel away as other social media platforms rise in popularity. How do you value that? I have no idea.
The metaverse business carries even more uncertainty. McKinsey thinks the metaverse could generate $5 trillion in spending by 2030. Under the best-case scenario, Meta could have a trillion-dollar business on its hands. But under the worst-case scenario, which is probably far more likely, its metaverse efforts will cost tens of billions of dollars and yield nothing meaningful.
Should you buy Meta stock?
You really have to believe in the metaverse story Meta is trying to tell to justify investing in the stock. If the metaverse doesn't pan out, you're left with aging social media apps and a company piling on ads to keep revenue from falling too much. That's not a recipe for long-term success.
I won't be buying Meta stock. With the market cap having fallen to around $350 billion, it sure looks cheap. But the best days for the advertising business are probably in the past, and the metaverse business looks more like a boondoggle than the next big thing to me.
