Considering its terrible business performance in 2022, you probably wouldn't have believed me if I had told you that Meta Platforms (META -2.41%) would start 2023 as the best-performing FAANG stock. Still, year to date, its stock has outperformed every other FAANG stock by almost doubling, up 93%. The next best-performing FAANG stock was Apple (NASDAQ: AAPL), which is up only 33%.
What's impressive is that, despite the colossal stock run so far in 2023, many Wall Street analysts believe Meta stock still has at least 20% more upside from current prices. So should you buy the stock today?
Let's see if we can answer that question.
Investors are betting on a turnaround
Shareholders are increasingly optimistic about Meta's ability to address two key issues negatively affecting advertising on Facebook and Instagram: Reduced ad effectiveness resulting from government and other consumer privacy initiatives, and competition from short-form video platforms like TikTok. These issues have led to a decline in advertising metrics and a loss of ad demand over the past year.
Moreover, since advertising is Meta's primary revenue generator, the drop in ad performance resulted in revenue growth that has looked terrible over the last several quarters.
META Revenue (Quarterly YoY Growth) data by YCharts
To counter the first issue -- government privacy regulations and Apple's iOS privacy changes -- Meta has started using artificial intelligence (AI) to create tools that could more effectively target users and measure ad performance while using less personal data. The company rolled out all its AI ad products, the Advantage+ Ad Automation Suite, in August 2022. As a result of its AI initiatives, marketers now see a higher ad return on investment in the platform, making Facebook and Instagram increasingly more attractive sites to place ads.
AI also gives Meta an advantage over many competitors. Excluding most of the company's FAANG peers, its competitors lack the resources to build AI infrastructure for advertising on a similar scale to this social media company. Remember, Meta built what it says is the world's fastest AI supercomputer in 2022.
To counter its second advertising issue, competition from short-form video platforms like TikTok and Snap (NYSE: SNAP), it has created its own short-form video platform, Reels, embedded in both the Instagram and Facebook platforms.
Generation Z and, to a lesser extent, millennials are addicted to short-form videos. For Facebook and Instagram to remain relevant to a younger audience, Meta needed to create Reels, or younger users would continue leaving its social media ecosystem -- along with the marketers wanting to advertise to that more youthful demographic.
The excellent news is that Reels is growing like a weed. According to CEO Mark Zuckerberg:
Reels continues to grow quickly on both Facebook and Instagram. Reels also continue to become more social with people resharing Reels more than 2 billion times every day, doubling over the last six months. Reels are also increasing overall app engagement and we believe that we're gaining share in short-form video, too.
Once the economy improves and the global ad market turns north, the company's revenue growth should reaccelerate with these improvements. But, additionally, investors expect substantially more of that top-line revenue growth to fall to the bottom line after Meta laid off thousands of workers and became intensely focused on cost savings. The company's efficiency drive has already reversed a downward trend in profitability, as shown in the below chart.
META Operating Margin (Quarterly) data by YCharts
The best part is that the stock still has plenty of upside just to reach its three-year median operating margin.
What could go wrong?
While the market likes the direction of the Family of Apps segment of the business, Zuckerberg's insistence on building out the metaverse worries some investors.
Meta's latest earnings report shows that losses in its Reality Labs segment continue to grow. The unpopularity of virtual reality (VR) headsets and the metaverse is particularly alarming. According to a Piper Sandler survey of 7,100 U.S. teens in 2022: "While 26% of teens own a VR device, just 5% use it daily. 48% of teens are either unsure or not interested in the metaverse." Unfortunately for Meta, Gen Z's disinterest in Zuckerberg's fantasy world helped produce lackluster results for its Reality Labs division. Revenue in first-quarter 2023 declined 51% year over year, which the company blamed on lower sales of its VR headset Meta Quest.
Even more disappointing: Several news outlets have reported that Zuckerberg announced substantial price cuts for its Quest 2 and high-end Quest Pro VR headsets on Instagram in early March. No one should expect a quick turnaround in this segment any time soon.
A significant risk for people who decide to invest in this company is the possibility that Zuckerberg will continue to pursue the metaverse vision, pouring billions of dollars into the concept, and it'll fail to pay off after a certain period. Eventually, the market could grow tired of management investing in a dumpster fire, and the stock could remain persistently undervalued, despite the success of the Family of Apps segment.
Why you still might want to buy it
The chart below shows that even after the stock's big run, it has a price/earnings-to-growth ratio (PEG ratio) of 0.948. Typically, a PEG ratio less than 1 indicates an undervalued stock.
META PEG Ratio data by YCharts
Suppose you believe that when the economy recovers, Meta's profits and free cash flow will jump much higher from the current level. Now is a great time to invest to benefit from the company's AI initiatives and efficiency improvements.
