It is uncommon for large companies with more than $10 billion in market capitalization to lose more than 70% of their value in a year. What happened to Meta Platforms (META 0.16%) in the last 12 months was almost unprecedented -- it lost more than $700 billion in market cap.
Bargain hunters are getting excited. But is it the right time to buy the stock now? Let's dig further.
Image source: Getty Images.
Meta's advertising business is struggling
When Meta reported a 1% decline in operating income for the fourth quarter of 2021, everyone was shocked. Such poor performance was alien to a company accustomed to delivering solid performance over the years.
But as Meta reported its performance in the subsequent three quarters, investors became horrified by what they saw. Groupwide operating income fell 25%, 32%, and 46% in the first, second, and third quarters, respectively, of 2022. Declining revenue and growing expense contributed to the lower operating income.
Once the bedrock of Meta's business, the advertising segment got hit hard by the challenging economy, competition from short-form video companies, and ads signal loss due to the change in Apple's IOS policy. Financially, the advertising segment delivered progressively lower income every quarter in 2022, from $11.5 billion in the first quarter to $9.3 billion in the third quarter.
The silver lining was that the family of apps (Facebook, Facebook Messenger, WhatsApp, and Instagram) delivered improved engagement levels in the third quarter of 2022, with daily active users (DAU) growing 4% year over year to 2.9 billion and monthly active users (MAU) improving 4% to 3.7 billion.
Meta's solid engagement levels suggested the weak financial performance was more likely a result of lower industrywide advertising activities -- plagued by a weak economy, the war in Ukraine, and so forth -- than its failure to retain and delight users. For example, Reels -- Meta's short-form video service -- delivered 140 billion plays per day, a 50% improvement from six months ago.
Meta is working to turn its advertising business around -- via Reels, investing in artificial intelligence, and improving monetization. It will take at least a few more quarters for investors to judge whether the recent fall in earnings is a blip or a permanent decline.
Meta's metaverse is burning cash rapidly
About a year ago, Facebook changed its name to Meta to reflect the pivot toward the metaverse. Meta's huge bet made sense -- J.P. Morgan predicted $1 trillion in revenue for this industry.
To gain a foothold, Meta invests heavily in its hardware (virtual reality, or VR, and augmented reality, or AR) and creates an ecosystem of users, developers, and partners. Meta's seriousness is evident in its financial numbers: Loss from Reality Labs grew 37% in the first nine months of 2022 to $9.3 billion, around 29% of the advertising business's profits.
But here's the problem. While losses ballooned, Reality Lab's revenue was almost flat over the same period. The weak topline performance suggested Meta's VR headset struggled to expand beyond its early adopters and raised the question of whether it was sensible to allocate almost a third of Meta's operating profits to metaverse projects.
While Meta has all the resources it needs (financial, talent, and technical know-how) to invest in and grow this venture, investors should closely monitor this segment's development. Further growth in operating losses without a noticeable topline growth will be a red flag.
But Meta is trading at a low valuation (for now)
Meta's weakening fundamentals have kept investors away from the stock. With a recent trailing price-to-earnings (PE) ratio of 8.5, the tech company was trading at a significant discount to its five-year average of 26.1.
But there's one caveat. If Meta fails to maintain this level of profitability, the current PE ratio will be irrelevant. In fact, if we annualize its third-quarter earnings per share of $1.64, Meta's PE ratio will increase to 13.6. Still low to its historical value, but not that low anymore.
In other words, Meta needs to maintain (or improve) its profitability in the coming months. If it fails, today's low valuation will be almost irrelevant.
So is it a buy?
Investors were cheering for Meta's solid performance amid the pandemic two years ago. Today, investors are pessimistic about Meta's prospects as it faces the abovementioned challenges.
It does not help that the investment in the metaverse is consuming cash rapidly, even as the advertising business's profitability is declining quickly. A declining cash cow and a cash-consuming unproven venture do not look attractive to investors.
Still, I think the advertising business may have reached its prime but is far from out of the game. It still hosts 3.7 billion MAU across its social media apps and generates billions in profits -- $9.3 billion in the latest quarter. Besides, Meta is banking on Reels to retain (and possibly improve) user engagement in the coming months.
While it may be difficult, even imprudent, to convince new investors to buy Meta's stock, existing investors may want to give the management team some time to turn the ship around. At least give it a few quarters more before making the next move.
