Meta Platforms' (META 0.14%) stock plunged 25% after its third-quarter earnings report last week. Revenue fell 4%, earnings per share was slashed in half, and the tech giant lost nearly $4 billion in Reality Labs, its division devoted to the metaverse.
Meta stock is now down more than 73% year-to-date as a result of the added earnings pain. But investors seem to be overreacting to at least one aspect of the report. Despite its weak results, the advertising business is in better shape than it looks, and recovery in the ad business is key to helping the stock rebound. Let's take a closer look at what the market is missing here.
Image source: Meta Platforms.
A wide range of headwinds
Advertising growth has slowed for a number of reasons over the last year. Apple's ad-tracking changes seem to be the biggest reason for the disappointing growth because the new policy made it harder to target ads. But the company has also faced increasing competition from TikTok as well as a difficult macro environment in which businesses are pulling back on ad spending in anticipation of a recession.
However, the good news for investors is that those challenges seem temporary.
While Apple's ad-tracking transparency initiative isn't going away, Meta leaders did say that the financial impact was fading as it laps the release of iOS 14.5 in the third quarter last year. CFO Dave Wehner said on the earnings call, "We're not going to be facing as significant headwinds next year from the signals point of view as we are now lapping the big changes that were made on the iOS platform."
On the TikTok front, Meta has been investing heavily in Reels, its TikTok-like short-form video feature, but it has yet to fully monetize this offering. At the same time, Reels is creating a $500 million headwind as it takes attention from products like News Feed and Stories. However, Meta's management team said that Reels is adding to time spent on the platform and that Reels' advertising has reached a $3 billion run rate on Facebook and Instagram.
Management also said the impact from Reels will be more neutral within the next 12 to 18 months. And, importantly, the company said it believed that Reels was gaining share of time from competitors like TikTok.
These macro headwinds do represent a challenge that could persist over the next few quarters, but the economy is cyclical. Advertiser demand will eventually come back. Meta experienced an accelerated version of that cycle during the pandemic, and digital advertising demand also plunged during the Global Financial crisis before making a robust recovery.
Is Meta stock a buy?
After last week's plunge, Meta stock looks dirt cheap according to traditional metrics. The stock trades at a trailing price-to-earnings ratio of less than 10. However, analysts expect the company's earnings per share to fall 40% in the fourth quarter, and they see a decline of roughly 15% next year as well.
There's also a wild card here in the form of Reality Labs. That business segment reported an operating loss of $3.7 billion in the third quarter, and it looks set to get worse next year -- Meta promised that operating losses in Reality Labs would expand significantly in 2023.
Meta expects to drive overall operating income growth after that as it controls spending on the metaverse segment, but the raise could come from a much lower base in operating income.
At this point, Meta's advertising business looks undervalued, especially since the headwinds are temporary. But the stock seems unlikely to recover until overall profits start to increase again or until Reality Labs proves that it has a viable business, which includes significant consumer demand for its headsets.
Neither of those things seems likely to happen until 2024 at the earliest. With that said, investors are best waiting on the sidelines for now as financial results seem likely to get worse before they get better.
