When your buddies tell you about a hot stock that has more than doubled in the past three months, it's usually not a $490 billion company. But that's precisely what Meta Platforms (META 1.54%) has done since early November.
That's a quick move for any company, let alone the 10th largest in the world. So has Meta moved too fast? Or is this just the start of a remarkable recovery? Read on to find out.
A huge repurchase plan but insufficient cash generation
Despite this rapid rise, Meta Platforms remains more than 50% off its all-time high reached in July 2021. The stock fell from its highs for two reasons. First, the stock was highly valued due to investor sentiment. Second, the drop occurred right around the time Meta Platforms changed its name from Facebook.
Now I'm not saying the name change is to blame, but I am blaming the business model shift to the metaverse. Since that shift, Meta Platforms has changed from a free cash flow (FCF) generating machine to one that spends nearly every dollar it brings in, at least up to the third quarter.
META Free Cash Flow (Quarterly) data by YCharts.
Yet, despite producing $5.3 billion in FCF during the fourth quarter, management feels it's prudent to repurchase up to $40 billion in shares. At Meta's current low-cash-generation state (compared to what it used to generate), it would need to drain its entire balance sheet of cash and marketable securities to fund this buyback -- which isn't feasible.
Additionally, in Q4, Meta's revenue fell 4% while expenses rose 22%, causing earnings per share (EPS) to drop 52% to $1.76. If you're looking for positive information in that sentence, it's impossible to find. However, investors thought this report was good enough to send the stock up nearly 25% after it came out.
So what's going on here?
Rapid stock rise likely due to a low valuation
Investors are likely excited about what co-founder and CEO Mark Zuckerberg had to say. He dubbed 2023 the "year of efficiency," which started with Meta laying off 11,000 employees in November 2022. Additionally, he hinted at more layoffs and spending less on capital expenditures. These changes should help Meta produce more FCF and self-fund the buybacks without draining its balance sheet.
It also won't have the restructuring costs weighing on its quarterly results. Meta incurred about $4.2 billion in such expenses in Q4 -- including $975 million in severance and other personnel costs. If that sounds high, that's because it is. It works out to about $88,600 per laid-off employee in severance costs. While that seems a bit egregious of a cost to me, it's done, and Meta's operating expenses can now benefit from a cost reduction.
These improvements should help Meta's struggling FCF generation, but they may not be why Meta's stock has risen so much. Three months ago, Meta's price-to-sales valuation took a severe nose dive.
META PS Ratio data by YCharts.
Not only was it low by Meta's historical standards, but low for a company with Meta's profit margins (even though they are shrinking). The rebound only takes it up to where it was during mid-2022, so this recovery can mainly be attributed to Meta returning to a reasonable valuation.
But I think it's a trap for investors. Meta has a lot going on with the challenging advertising environment and a reality labs division that has been burning cash. While the changes coming in 2023 are welcome, the odds of Meta Platforms returning to its FCF-generating glory day sare likely over unless one of its metaverse projects hits it big. If it does, Meta will likely be a massive winner from here on out. If it doesn't, investors could lose a lot of money.
I'd rather invest in a steady business that isn't counting on one trend to pan out, so Meta Platforms doesn't seem like an investable business today, even if its stock has performed well recently.
