Investors who bought Meta Platforms (META -0.07%) in the beginning of the year are laughing all the way to the bank. As of this writing, the stock has risen 136% year to date. Two consecutive quarters of improving performance have given investors the hope that the worst could be over for the company.
But for those who missed the boat early on, is now the time to change course and buy the stock?
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Meta's advertising business is back on track
Meta's advertising business has been a golden goose for the company, churning out consistent and growing profits over the years. That trend, however, came to a halt in 2022 as the company reported a 1% fall in revenue and a 25% decline in operating profit.
Investors were shocked by those unfamiliar numbers, sending Meta's stock down to a five-year low of $88. In response, Meta took some aggressive steps, which include massive layoffs and bringing back management focus on its core advertising business. Fortunately, there are already early signs that this business might have seen the worst.
For instance, revenue returned to positive growth of 4% in the first quarter of 2023, which was a turnaround from a negative 4% in the fourth quarter of 2022. This trend sustained in the second quarter of 2023 as Meta grew its advertising revenue by 12% and operating profit by 18%. Besides, engagement levels also improved as the family daily active people (DAP) and Facebook daily active users (DAU) grew 7% and 5%, respectively.
Meta's solid turnaround indicates that the worst might be over for the company, and that it's on track to return to its growth mode. To this end, the company has room to further improve monetization of services like WhatsApp, Reels, and Messenger. Besides, it can also grow its average revenue per user (ARPU) in regions beyond its core markets, such as Asia-Pacific. For perspective, the ARPU in Asia Pacific is less than 10% of the U.S. market.
In short, there are still growth opportunities for Meta in the years to come.
Meta's bet on the metaverse
While Meta's advertising business is the massive cash cow today, the company hopes that its Reality Labs division -- which bets on the metaverse -- can be a future revenue generator. And it's betting heavily on this venture, resulting in a $7.7 billion operating loss in the last six months alone -- much more if we consider all the prior investments.
Meta's heavy bet on this segment, on one hand, looks perfectly rational. Envisioned as a vast, interconnected digital universe, the metaverse holds the potential to revolutionize how we work, socialize, learn, and entertain ourselves. As this virtual world develops, it will open up huge opportunities that we haven't seen before. The early indication is that the industry will be worth $1 trillion -- and could grow further.
But here's the problem. We do not know how the metaverse will evolve, and who will be the leading player going forward. While Meta has a great position to start with -- thanks to its huge resources including its massive cash position, 3.9 billion monthly active users, its massive ecosystem and technological advancement -- there is no guarantee that it can replicate that in this emerging industry.
Yet, it's spending excessively on this single bet, which could result in massive destruction in shareholder value if the project fails to live up to expectations. Worse, there is nothing minority shareholders can do since founder and CEO Mark Zuckerberg has 61% voting power.
In short, the metaverse remains a high-risk (and potentially high-return) bet.
A quick word on Meta's valuation
No stock investment decision is complete until you consider the valuation of the stock. After its recent surge, Meta's stock is trading at a price-to-earnings (P/E) ratio of 34 times, which is higher than its five-year average of 25 times. By comparison, Alphabet has a P/E ratio of 29. In other words, investors are not getting any advantage in terms of valuation. They must be willing to pay for the premium to own the stock today.
So is Meta's stock a buy?
Meta's recent performance shows that the advertising business remains an unusually profitable business -- and it's back on its growth trajectory.
The metaverse bet, however, remains a highly uncertain yet expensive venture that will consume cash from the advertising business. Besides, Meta's stock is no longer trading at an attractive valuation after its huge rally over the last few months.
On balance, while existing investors need not rush to sell Meta's stock given the strength of its advertising business -- they can hold on to the stock for now -- new investors may be best served staying on the sidelines.
