The last few weeks may feel like months for investors trying to make sense of huge swings to the upside and the downside in the broader market. The Nasdaq Composite's (^IXIC +1.71%) over 12% pop on April 9 pole-vaulted the index out of bear market territory -- which is a decline of over 20% from a recent high. However, a subsequent sell-off on Thursday pushed the Nasdaq within striking distance of being back in a bear market.
Bear markets have historically been phenomenal times to put hard-earned savings to work in the market, but only for businesses that have the qualities necessary to endure a prolonged slowdown. Here are some risks worth considering before diving headfirst into buying the dip, and why Meta Platforms (META 1.18%) passes the risk test.
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1. Free cash flow
Bear markets can happen for a variety of reasons -- such as valuation concerns, economic slowdowns, and recessions. In this case, the major risk is that tariffs will lead to higher costs, lower demand, lower spending, and a potential recession.
Companies that generate high free cash flow (FCF) with strong profit margins are well positioned to endure a period of higher tariffs. Meta is a perfect example.
Meta's family of apps, which includes Instagram, Facebook, and WhatsApp, relies on ad revenue. Ad revenue is high-margin because Meta has few operating costs besides paying employees and managing its platforms.
The social media giant is ramping up capital expenditures to support its artificial intelligence (AI) efforts. It is also deploying considerable capital toward research and development for its Reality Labs division, which handles augmented reality and virtual reality products like Meta Quest. But these investments aren't essential for supporting the core business.
The company has many levers it can pull to generate tons of FCF, even during a recession. It can reduce capital expenditures and Reality Labs spending. From a capital return perspective, it could also pull back on stock repurchases.
In 2024, Meta generated a staggering $54.1 billion in FCF on a revenue of $164.5 billion. The company returned the majority of that FCF to shareholders -- including through $30.1 billion in buybacks. And Meta began paying a modest dividend last year.
All told, Meta is raking in the FCF even as it loses money on its Reality Labs segment -- a testament to the profitability of its family of apps and Instagram's growth.
2. Financial health
Another risk worth considering before buying growth stocks during a bear market is financial health. If a company's capital structure depends on debt, making interest payments and managing that debt will become more difficult if profits fall.
Similarly, if a company has high fixed costs and has to spend a lot of money to make money, that risk could be amplified during an economic slowdown.
Meta Platforms isn't just a high-margin business, it also has an impeccable balance sheet. Meta closed out 2024 with $43.9 billion in cash and cash equivalents and $33.9 billion in marketable securities compared to just $28.8 billion in long-term debt. That means Meta has plenty of cash to navigate the cycle through long-term investments, acquisitions, etc. The company's FCF provides a cushion to buy back stock, and the balance sheet is yet another margin of error that Meta has to endure a downturn.
3. Living up to shareholder expectations
Another risk to consider is shareholder expectations. The valuation of growth stocks is determined more by future expectations than present conditions, reflecting their current high prices. If the trajectory looks sound, the market may be willing to pay a premium price for shares today. But if forecasts turn murky, investors may wait for more certainty.
The period of higher interest rates over the last few years has been damaging to companies that depend on debt and spending money to scale up to a level where they can turn a profit. Similarly, a prolonged period of tariffs could stunt growth trajectories, making valuations look more expensive relative to medium-term earnings expectations.
Defining shareholder expectations for any company is an abstract exercise. But for a company like Meta, I would imagine that investors mostly just want to see steady growth and high margins from the core family of apps. The success or failure of Reality Labs probably isn't even factored into the valuation that much, given Meta trades for just 22.9 times trailing earnings and 26.5 times FCF. AI-fueled growth would be a bonus, but the company is already doing so well.
As for the capital return program, the dividend could become something similar to what companies like Microsoft, Broadcom, and Oracle have done -- which is paid and raised their dividends for 15 consecutive years -- although none of these companies have high yields. The dividend, like buybacks, is just an added way to return capital to shareholders. But on its own, it doesn't make or break the investment thesis.
NASDAQ: META
Key Data Points
A foundational growth stock to buy now
Meta checks all the boxes for a beaten-down growth stock to buy during a Nasdaq bear market. The company is a high-margin cash cow coming off a record year. Should free cash flow fall temporarily, the company could still support its operating expenses by pulling back on spending and buybacks.
The balance sheet has a massive net cash position -- providing a cushion in case of a serious recession. Meta doesn't have to come out with a new product or live up to lofty expectations. Rather, it just has to continue driving traffic and engagement on its family of apps to attract ad spending.
Meta's resilience to the mentioned risks offers investors a model for identifying promising investment opportunities in the current market.
