Meta Platforms (META -11.76%) has been working for years to build out a social media empire and plowed an extraordinary amount of money on acquisitions. (I'm looking at you, WhatsApp and Instagram.) It also has been spending heavily on research and development.
In the past, even in the midst of scandals and Congressional hearings, the stock would inevitably continue to rise -- even after brief respites. When Meta reported its third-quarter results, however, shareholders were taken aback by the company's second-successive quarter of year-over-year revenue declines. This left investors wondering what's next for the tech giant.
The macroeconomic conditions over the past year and the "is-it-or-isn't-it" recession have only added fuel to the fire, which was evident in Meta's financial performance. Revenue of $27.7 billion declined 4% year over year, though to be fair, it would have grown 2% if not for foreign-currency headwinds.
These factors weighed on the company's profits, as diluted earnings per share (EPS) of $1.64 slumped 49%. For context, analysts' consensus estimates forecast revenue of $27.4 billion and EPS of $1.89. While revenue edged out expectations, profits badly missed.
The next big thing or boondoggle?
Investors are rightly concerned about two aspects of Meta' results. Obviously, the first concern is the company's sagging advertising growth, which is responsible for more than 97% of its revenue. While the social media baron still eked out growth, 2% gains is hardly worth writing home about. Furthermore, given the weakening economy, marketers will no doubt continue to rein in ad spending, which will subsequently weigh on Meta's future results.
The second concern is heavy spending on the metaverse. Even as investor concerns mount, Zuckerberg seemed to double down in his resolve. "We expect Reality Labs expenses will increase meaningfully again in 2023," the chief executive said on the conference call. Zuckerberg went further, saying the company expects Reality Labs' operating losses next year "will grow significantly." This didn't sit well with shareholders.
Reality Labs already accumulated roughly $10.2 billion in losses in 2021. It's on pace to surpass that this year, with losses of more than $9.4 billion during the nine months ended Sept. 30.
Not only has Meta's growth slowed to a crawl, but the company also continues to spend like there's no tomorrow, giving investors pause -- especially given the unproven attraction of the metaverse. If the broad adoption some expect fails to materialize, the metaverse could be nothing more than a big money pit.
Given the specific challenges outlined above, Meta's outlook didn't offer investors any comfort. For the upcoming fourth quarter, management expects revenue in a range of $30 billion and $32.5 billion, which would represent a year-over-year decline of between 3% and 11%. Factoring in the planned heavier spending, the bottom line will also take a hit.
Now what?
It's always darkest before the dawn, or so the old saying goes. When things look the worst, that's usually the best time to pause, take a breath, and look at the big picture. It doesn't take long for dark clouds to blow away, revealing beautiful skies.
Investors shouldn't overlook the relentless growth of Meta's user base. In the third quarter, 3.71 billion people used one of Meta's family of products every month, up 4% year over year. This creates an incredible network effect that shouldn't be overlooked.
Image source: Statista.
Regarding its increasing costs, Meta isn't completely oblivious to investor concerns and provided some insight into its reasoning. One of the biggest areas of capital spending over the coming year will be investment in its data centers. The company believes that increasing its capacity will result in greater flexibility, ultimately resulting in "greater cost efficiencies over time."
In fact, the company's rising costs are all under the microscope, according to CFO Dave Wehner. "We have increased scrutiny on all areas of operating expenses," he said. He also noted that, "We expect hiring to slow dramatically going forward." This suggests that investor concerns about rising costs haven't completely fallen on deaf ears.
It's also important to keep in mind that we're in the midst of an economic downturn, with companies and consumers alike scaling back on spending. This is particularly true of marketing, as advertising is one of the first areas to be slashed when times get tough. When the economy rebounds, as it eventually will, things will seem far different.
There's also the strong dollar to consider, which continues to weigh on Meta's results. This caused a 6% hit to the company's revenue and is part of the natural cycle of currency. What goes up will eventually go down, benefiting Meta when it does.
Even as challenges mount, Meta continues to be a cash-generating machine, with free cash flow of roughly $13.2 billion so far this year. This gives the social media giant plenty of resources to commit to future growth -- metaverse or otherwise. The current environment could push that lower in the short-term, but its position as one of the world's leading digital advertisers is secure.
Growth may be going in the wrong direction right now, but the tide will turn, and Meta is well-positioned to reap the rewards. Worldwide digital ad spending is expected to grow from $521 billion last year to $876 billion by 2026, according to Statista. Meta is one of the industry leaders: As the pie grows, so grows Meta's opportunity.
Finally, there's the matter of valuation. Meta is selling for less than 9 times earnings, the stock's cheapest valuation ever. For context, the Nasdaq 100 is trading at a price-to-earnings ratio of 23.
Even with challenges ahead, Meta stock is a buy.
