Over the last year, a big contributor to the momentum in the market has been hype around artificial intelligence (AI). The overall bullish outlook on the technology seems to have carried over into 2024. This week, the S&P 500 closed at an all-time high level of 4,868.55.
Some of the biggest contributors to the market over the last 12 months are the "Magnificent Seven" stocks -- a moniker used to describe the largest technology enterprises by market cap. As of the time of this article, five of the Magnificent Seven stocks boast market capitalizations of over $1 trillion -- Apple, Microsoft, Alphabet, Amazon, and Nvidia. However, with a market cap of $980 billion, Meta Platforms (META 0.43%) could very well be the next to join and firmly remain in the exclusive club.
In 2023, Meta stock returned 194% -- handily outperforming the broader markets. With such outsize returns and the overall market soaring to new highs, is it time to book some gains in Meta stock?
A thorough analysis of the company's financial and operational picture may show that the stock trades for a bargain. Let's look at Meta and assess if now is a good opportunity to scoop up some shares.
Meta's financial profile is rock-solid
In 2022, Meta made a big bet on virtual reality (VR) as it turned its focus to the metaverse. However, investors quickly soured on these new ambitions as the company's revenue decelerated and expenses rose. While the metaverse is still part of the company's long-term vision, Meta spent much of 2023 returning to its advertising roots and right-sizing its cost profile.
Through the first nine months of 2023, Meta's total revenue increased 12% year over year, while free cash flow grew by 140%. A return to advertising growth coupled with multiple rounds of layoffs helped Meta get back on track. As such, the company has been able to swiftly reinvest these excess profits back into the business.
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What growth drivers does the company have?
When it comes to AI, Meta has a couple of interesting opportunities.
First, the company already has a series of VR hardware devices through its Reality Labs business. Currently, Reality Labs only constitutes about 1% of Meta's total revenue. Moreover, hefty research and development (R&D) and marketing costs are taking a toll on this division, as it does not yet generate positive operating margins.
Nevertheless, one of the company's recent augmented reality (AR) developments could be a tangential growth driver for Meta's current VR headsets and the overall Reality Labs business. Meta's smart glasses are a unique new piece of hardware the company is testing. Although competitors like Alphabet have attempted to commercialize similar products in the past, I am bullish that Meta will be able to integrate smart glasses into its existing VR and AR infrastructure and bolster its Reality Labs operation.
Another catalyst Meta currently has is its generative AI model, Llama 2. Llama 2 already has many impressive partners, including cybersecurity firms such as Palo Alto Networks, workplace automation services including Atlassian, and cloud providers like Microsoft and Amazon Web Services (AWS). Each of these end markets is enormous and becoming increasingly reliant on AI applications. While it's still early days, Meta is quietly setting itself up to enjoy long-term secular tailwinds from key markets such as cloud computing, among others.
Meta stock looks like a bargain
As of the time of this article, Meta stock is already up 8% this year. But even so, the company trades at a forward price-to-earnings (P/E) ratio of 21.9 -- nearly identical to that of the S&P 500. This could signal that investors do not expect Meta to outperform the broader markets.
META Price to Free Cash Flow data by YCharts
I see Meta as an undervalued growth stock whose ambitions in artificial intelligence are not fully understood. Meta stock looks historically cheap at a price-to-free cash flow of just 26.7. Moreover, given the toll Reality Labs currently takes on Meta's overall profitability, the company's total earnings could actually be even higher -- suggesting the stock could be even cheaper than it looks.
As concerns around the macroeconomy begin to improve, Meta looks well-positioned to benefit from the AI movement -- an industry that can fuel both the company's advertising and VR businesses. While it's already experienced a slight bump in the first few weeks of the year, now still looks like an incredible opportunity to scoop up shares in Meta given the stock's discount to historical valuations.
