The metaverse was a hot topic last year, but the hype has largely fizzled out now that virtually every metaverse stock got hammered throughout 2022. That includes Meta Platforms (META -4.84%), my favorite metaverse stock entering 2022. Instead of rising, the stock is down 66% since the start of the year.
Ironically, there's arguably more evidence today than last year that brighter days are ahead. Meta stubbed its toe on some short-term challenges, but there are at least three reasons why the stock could still deliver 25% investment returns in 2023.
1. Meta's moneymaker is still strong
Most investors are fixated on Meta's metaverse ambitions, but the Family of Apps segment that houses Facebook, Instagram, and WhatsApp is still what butters Meta's bread. Broad recession fears are hurting advertising companies like Meta, but ad spending is a cyclical business that should recover once confidence in the economy returns.
One could instead judge Meta's advertising business by its user growth, which is still trudging forward despite the enormous footprint Meta's apps already have. As of 2022 Q3, Meta's apps total 2.93 billion daily active users and 3.71 billion monthly users, a 4% increase over Q3 last year.
Considering the world's population is 8 billion people, and not everyone has access to the net, Meta's continued user growth is a sight to behold, and it illustrates how sticky the apps are for people worldwide. Forbes highlighted the most downloaded smartphone apps worldwide as of Q3 of 2022, and Meta's apps held three of the top four spots. As long as user growth continues, it's hard to be too down on Meta's advertising business. Brands will eventually open their wallets again, and Meta's revenue should get a spark when they do.
2. Some financial discipline is coming to the metaverse
Meta's stubborn and expensive metaverse ambitions are the most significant reason Wall Street turned a cold shoulder on the stock. CEO Mark Zuckerberg wasn't kidding when he outlined his plans to invest tens of billions to develop the company's metaverse business Reality Labs. You can see below just how much has already poured in, and the result has been a staggering $9.4 billion in operating losses through nine months of 2022. Zuckerberg told investors that Reality Labs will lose even more money in 2023.
META Capital Expenditures (TTM) data by YCharts
But Zuckerberg maintained from the jump that Reality Labs would take years to show a return on investment, so shareholders shouldn't be surprised. However, Zuckerberg does appear to be listening to Wall Street's dismay toward the company's spending. Meta recently announced that it's laying off about 13% of its workforce (about 11,000 jobs) to save between $1 billion and $2 billion annually.
META Free Cash Flow (Quarterly) data by YCharts
Does it change the narrative that Meta's spending a ton of money? No, but Meta's free cash flow was virtually nil in Q3, so some cost-cutting could help prevent Zuckerberg from tapping into Meta's balance sheet to fund Reality Labs.
3. Meta is not the value trap some say it is
Lots of folks bullish on Meta are pointing to the stock's depressed valuation, while those skeptical are calling it a value trap, a stock that appears cheap but has fundamental problems that make it cheap for a reason. At least from a historical perspective, Meta is indeed a bargain. The company's median price-to-earnings ratio (P/E) is 34, but it's just 10.6 today.
Meta's declining free cash flow and slow advertising business show that there are problems at Meta, but is the company fundamentally broken? That might be going a little too far; analysts are calling for earnings-per-share (EPS) growth averaging 8% annually over the next three to five years. In other words, Meta should still grow its bottom line despite all of these problems. The S&P 500 has averaged about 10% growth throughout its history and currently trades at a P/E of 21.
A 20% lower growth outlook might translate to a similar discount to the market's valuation, so perhaps Meta should have a P/E of 17? Even if the numbers change some, there's a massive gap between where Meta's stock might make sense and where it trades today. If Meta's business picks up or continues cutting costs, the potential improvement in sentiment among Wall Street could easily rerate the stock upwards. Even a 25% move would only value the stock at a P/E of 13, so there seems to be room for solid investment returns if the dominos fall right. Will that happen in 2023? Nobody can predict that with certainty, but the pieces are there for Meta to become one of Wall Street's turnaround stories in 2023.
