One of the underlying themes from the COVID-19 pandemic is that technology companies in particular experienced an unforeseen influx of business. For example, as remote work became the default option, cybersecurity firms and cloud computing applications saw booming demand.
Another area that witnessed high growth was e-commerce. Companies like Amazon and Meta Platforms (META 0.43%) saw a huge uptick in online advertising and shopping. However, another underlying theme from the pandemic was that as companies generated record revenue and profits, some reinvested this excess cash into new, non-core initiatives.
As a result, many companies overhired and subsequently resorted to layoffs. In early February, Meta Platforms CEO Mark Zuckerberg declared 2023 the "year of efficiency" during the company's fourth-quarter earnings call. Effectively, Zuckerberg made it clear that Meta was returning back to its roots: advertising. Its longer-term investments, namely the metaverse, were going to take a back seat.
The company just released results for the first quarter of 2023. One thing is clear: Following the earnings call, Meta's stock rocketed as investors cheered the company's progress exercising cost discipline. However, what is more challenging is assessing if all of the good news is priced into the stock. Let's dig into Q1 results and analyze the fundamentals of the business to see if Meta is a good buy right now.
Q1 at a glance
For the quarter ended March 31, Meta generated $28.6 billion in revenue, which represented a 3% increase year over year. For several quarters now, Big Tech warned of slowing consumer demand due to fears around lingering inflation and a potential recession. Subsequently, competitors like Alphabet experienced major slowdowns in revenue from advertisers as end-customers tighten corporate budgets.
So while Meta generated some form of top-line growth, it may not be a big reason to celebrate. The company's cost of revenue increased by 10% annually, which was primarily driven by rising research and development costs, and general and administrative costs. However, it's important to note that cost of revenue also included $1.1 billion of restructuring charges related to the company's layoffs. Even if these costs are backed out, the key takeaway here is that costs rose faster than revenue during Q1.
Image source: Getty Images.
The muted revenue growth and rising costs impacted Meta's profit margins, which dropped from 31% in Q1 2022 to 25% in Q1 2023. The margin deterioration directly impacted Meta's cash profile, as the company ended Q1 with $37.4 billion in cash and equivalents compared to $40.7 billion as of Dec. 31.
Another important takeaway is that Meta ended Q1 with roughly 77,000 employees. This figure is net of all of the employees impacted by the first round of layoffs in November. However, employees who are impacted by Meta's second round of layoffs announced in early 2023 are included in this figure. This means that the company's Q2 results should reflect further cost reductions. Moreover, management announced that the company is planning a third round of layoffs to be carried out later this year.
What does Wall Street think?
Following Q1 results, research analysts from Goldman Sachs, Citigroup, Truist Securities, Deutsche Bank, and Guggenheim all released revised price targets.
The key themes? All of these financial institutions have a "buy" rating on the stock, and each analyst believes Meta is currently undervalued. As of the time of this article, Meta trades around $233 per share.
Goldman Sachs believes the intrinsic value of Meta stock is $300, implying 28% upside to current levels. Citigroup and Guggenheim are even more bullish, slapping price targets of $315 and $320, respectively, implying well over 30% upside.
Deutsche Bank's price target estimate is $290 which implies 24% upside, while Truist has modeled 13% upside and a price estimate of $265 per share.
Investors should be encouraged that so many reputable institutions on Wall Street believe there is so much more upside potential for Meta, especially considering that the company still has two more rounds of cost reductions to implement.
Keep an eye on valuation
As of the time of this article, Meta's price-to-earnings (P/E) ratio is 30. For reference, the long-run average P/E ratio of the S&P 500 index is around 15 to 16.
It's important not to get too persuaded by valuation metrics. First and foremost, Meta's earnings per share (EPS) are down 19% on an annual basis. However, since the earnings report in late April, Meta's stock is up roughly 11%.
In this scenario, the numerator portion of the P/E ratio has increased pretty dramatically in a short amount of time. By contrast, the denominator (EPS) is shrinking compared to the prior year's comparable period. While it seems a little convoluted that a stock price would rise when earnings fall, investors should remember that the stock market contains a lot of emotion.
Sometimes investors buy or sell based more on emotion than sound fundamental logic. In the case of Meta, the company was able to generate top-line growth during an otherwise cloudy macroeconomic environment. Furthermore, management made it clear that it is committed to further cost reductions, which should positively impact the bottom line.
While buying into momentum may not be the most prudent action, long-term investors should look for an opportunity to buy shares in Meta when the time is right. Between now and the next earnings call, it is highly unlikely that the stock will continue to rise. However, waiting too long for a heavy sell-off is also not recommended. Time in the market is more important than timing the market. Given the high probability of continued cost reductions and profit generation, Meta is laying the groundwork to set itself up for long-term growth. Furthermore, the positive sentiment on Wall Street illustrates that there is the potential for significant upside in the stock, making it an attractive buy.
