Meta Platforms' (META -4.13%) stock price sank 20% to its lowest levels in nearly seven years after it posted its third-quarter earnings report. The social media giant's revenue fell 4% year over year to $27.7 billion, which cleared analysts' estimates by $310 million but marked its second consecutive quarter of declining revenue. Its net income plunged 52% to $4.4 billion, or $1.64 per share, which broadly missed the consensus forecast by $0.22.

Meta's dismal results weren't surprising, since Snap (SNAP -4.04%) and Alphabet (GOOG -1.10%) (GOOGL -1.23%) had also recently posted soft ad sales growth in their latest quarters. Meta's investments in its virtual reality (VR) devices and short video content had also been expected to squeeze its operating margins and throttle its earnings growth.

Meta CEO Mark Zuckerberg.

Image source: Meta Platforms.

However, Meta's steep post-earnings sell-off indicates investors aren't willing to forgive those flaws anymore. Inflation, rising interest rates, and other macro headwinds are driving investors toward more conservative investments. Can Meta impress investors again over the next 12 months, or is this stock doomed to stagnate or drop even further?

How ugly was Meta's slowdown?

Meta's growth in revenue, MAP (monthly active people) across its family of apps (Facebook, Messenger, Instagram, and WhatsApp), operating margins, and net income was strong throughout 2020 and 2021, even as the pandemic temporarily disrupted digital ad sales. But some huge cracks appeared over the past three quarters.

Segment

Q3 2022

Q2 2022

Q1 2022

2021

2020

Revenue growth (YOY)

(4%)

(1%)

7%

37%

22%

Family MAP growth (YOY)

4%

4%

6%

9%

14%

Operating margin

20%

29%

31%

40%

38%

Net income growth (YOY)

(52%)

(36%)

(21%)

35%

58%

Data source: Meta Platforms. YOY = Year over year.

That slowdown occurred because its core advertising business, which generated 98% of its revenue in Q3, faces three main headwinds: Macroeconomic challenges for digital ads, competition from ByteDance's TikTok, and Apple's (AAPL -1.22%) privacy changes on iOS. The strengthening dollar is also reducing its overseas revenue.

To stop that bleeding, Meta has been aggressively promoting its short videos on Instagram Reels and Facebook Watch -- but that strategy has been reducing its near-term margins because short videos are more difficult to monetize than regular ads. It's also been investing in more first-party data mining solutions to counter Apple's platform changes, which primarily targeted apps that were heavily dependent on third-party data.

But as Meta ramps up its spending on short videos and first-party data, it's also burning billions of dollars to expand the Reality Labs' metaverse with new devices and software. This segment, which generated just 1% of Meta's revenue in Q3, has lost a whopping $26.3 billion over the past 33 months while generating a mere $4.9 billion in total revenue.

Segment

Q3 2022

Q2 2022

Q1 2022

2021

2020

Reality Labs revenue

$285 million

$452 million

$695 million

$2.28 Billion

$1.14 Billion

Reality Labs operating income

($3.67 billion)

($2.81 billion)

($2.96 billion)

($10.19 billion)

($6.62 billion)

Data source: Meta Platforms.

That's deeply troubling since Meta's Horizon Worlds platform (for its VR users) reportedly peaked at about 300,000 active users in early 2022 -- and now only serves about 200,000 users. That's a tiny drop in the pond compared to the 3.71 billion people who access its family of apps every month.

If we exclude the Reality Labs segment from Meta's Q3 numbers, its operating margin would jump from 20% to 34%. That's why many investors have been urging Meta to downsize (or completely eliminate) this struggling division.

Will Meta get its act together over the next 12 months?

Meta expects its revenue to decline 3% to 11% year over year in the fourth quarter, which includes a seven-percentage-point drop from currency headwinds. The midpoint of that guidance implies its revenue will dip 2% for the full year, compared to analysts' expectations for a 1% decline.

Analysts expect Meta's operating margin to decline to 28% this year and slip to 27% in 2023, but those estimates could be far too optimistic in light of the company's near-term spending plans. Meta expects its total expenses to rise from $85 billion to $87 billion in 2022 to $96 billion to $101 billion in 2023. During the conference call, CFO Dave Wehner warned that the Reality Labs division's operating losses will still "grow significantly year over year" in 2023 as it rolls out its next Quest headset.

Simply put, investors should brace for sluggish revenue growth, rising expenses, and shrinking margins throughout 2023. Only two catalysts might bring the bulls back to Meta: the stabilization of its advertising business, or the complete shutdown of Reality Labs. But I don't expect either of those things to happen anytime soon.

Meta's stock might seem cheap at 11 times forward earnings right now, but it won't command a higher valuation until it resolves those pressing issues.