Meta Platforms (META 2.10%) reported its third-quarter earnings on Oct. 26, giving the bears everything they needed to prove their point. It's not like Meta was performing well to date, either. Meta is down more than 70% for the year, including a 24% drop following the Q3 report.
However, don't let anyone tell you Meta Platforms' business is dead, as the company still produced $27.7 billion in revenue in Q3. But if you decide to invest, you must pay attention to these three red flags.
1. Reality Labs is failing
Perhaps the most controversial subject with Meta Platforms stock is its switch from a social media platform to one focusing on the metaverse. Before Facebook changed its name to Meta Platforms, it was a profit-generating machine that was growing rapidly. However, with the name change came a shift in business focus, a move that doesn't look like it's paying off so far.
In the third quarter, the Reality Labs division (which deals with augmented and virtual reality products and software) only generated $285 million in sales. Why is that significant? Well, it is the lowest revenue this segment has generated over the past two years and indicates a 49% year-over-year fall in sales.
For a company that is supposed to be one of the leaders in bringing about the metaverse, it's not going in the right direction.
Throw in Reality Labs' worst operating loss over the past two years at $3.67 billion, and investors should be very concerned about the Reality Labs division. To make matters worse, management's 2023 guidance includes widening operating losses throughout 2023.
But investors shouldn't write it off yet. The holiday season is coming, and consumer demand may turn this division around. But I'm not holding my breath with consumers likely unwilling to spend big money on the latest tech gadget this year.
2. Sales and marketing spending is ramping up, with no revenue growth
Overall, Meta Platforms' revenue fell 4% year over year in the quarter. However, expenses continued to rise, especially in the sales and marketing department.
| Sales and Marketing as a Percentage of Total Revenue | ||||
|---|---|---|---|---|
| Q3 2021 | Q4 2021 | Q1 2022 | Q2 2022 | Q3 2022 |
| 22% | 21% | 28% | 30% | 33% |
Data source: Meta Platforms.
While I'm no marketing genius, I can tell you one thing: A company advertises to increase sales. When a business's advertisement budget spending ramps up 50% year over year, it better show some serious results. Instead, the result of the spending increase was a 4% year-over-year revenue decrease.
Meta Platforms needs to reconsider its marketing strategy or reduce its spending if the advertisements don't have the intended effect.
This change may be exactly what management is planning, as its business outlook included maintaining or reducing head counts in some areas and further scrutinizing operating expenses. However, management gave itself an easy out by defending its decisions, stating these expenses are part of a long-term investment trajectory, and it may be a while before they pay off.
But with the current trajectory, Meta Platforms may not have profits for long.
3. Meta Platforms' profits are on track to go extinct
Meta's net income fell 52% year over year to $4.4 billion in Q3, which continues the downward trend that has been present throughout 2022.
| Meta Platforms' Quarterly Net Income | ||||
|---|---|---|---|---|
| Q3 2021 | Q4 2021 | Q1 2022 | Q2 2022 | Q3 2022 |
| $9.19 billion | $10.29 billion | $7.47 billion | $6.69 billion | $4.4 billion |
Data source: Meta Platforms.
You'd think management would be more cost-conscious as profits evaporate, but that's far from the case. In Q3, Meta's capital expenditure bill was $9.52 billion, over double last year's total. This spending brought its year-to-date total to $22.81 billion, with the total projected to be about $32 billion to $33 billion by the time 2022 is over.
However, management thinks it's prudent to ramp up its expenses for 2023 instead of scaling back. In 2022, total expenses should come in between $85 billion and $87 billion, but 2023 will see that increase to between $96 billion and to $101 billion.
With the increased expenses, Meta may begin to walk the line of profitability. The backlash will be tremendous if Meta reports a quarter in which it loses money.
I'm unsure if that will happen in the fourth quarter, in 2023, or ever, but if Meta doesn't get its expenses in order, investors won't want to stick around. Investing in Meta Platforms may be perilous right now, and investors need to know what they are getting into if they decide to purchase Meta stock.
