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After Meta Platforms (META -1.08%) released its third-quarter 2022 results in October, the stock dropped 25% overnight. The company is suffering from multiple issues, ranging from a weak macroeconomy to poor company performance to some investor displeasure with the company’s direction.
However, Meta sells at a price-to-earnings ratio (P/E) of 11.3, well below the S&P 500 market’s P/E of 20. As a result, some consider the stock grossly undervalued, especially considering its ability to generate revenue and earnings once the economy rebounds.
Is it a good idea to take a contrarian stance against poor market sentiment for Meta and buy the stock or stay far away? Let’s take a look.
Investors will quickly sell any stock with shrinking revenue and rising expenses in today’s high-inflation and rising-interest-rate environment. Unfortunately for Meta Platforms, revenue shrank 1% year over year in its second quarter of 2022 and declined 4% year over year in the third quarter. At the same time, costs and expenses rose 22% in the second quarter and 19% in the third quarter. For these reasons, Meta has dropped 65% year to date.
One culprit for revenue declines and rising costs is that Apple‘s iOS privacy changes decreased Meta’s ability to target users and measure ad performance. This lowered advertiser demand for its ads while negatively impacting revenue. As a result, the company needed to retool its advertising infrastructure — a costly activity that could take several years to complete.
A second threat that Meta faces is competition. Over the last several years, Snap and TikTok have been grabbing ad market share by creating an attractive product for young adults — short-form videos. In response, Meta changed the focus of its operations to make products more appealing to young adults.
The first product Meta introduced out of its new young-adult focus is the short-form video product Reels, introduced to Facebook in February 2022. Unfortunately, this new, immature product monetizes less than Meta’s more mature ad products, resulting in less revenue generated. As a result, investors must monitor whether the company can improve its monetization of short-form videos and any future young-adult-focused products.
Meta is the king of user engagement, an important metric to measure how effectively a company gets a customer to use a product or service. When a website successfully captures a user’s attention, that user is more likely to interact with sponsored content and buy products or services more often.
One of social media companies’ best measures of user engagement is the daily active users (DAU) to monthly active users (MAU) ratio. A website is elite when the DAU/MAU ratio is above 60%. The excellent news for Meta is that the ratio for its entire family of properties (Facebook, Instagram, Messenger, and WhatsApp) is a mind-blowing 79%! These numbers mean Meta owns some of the most effective online-advertising properties globally.
In addition, these online properties enjoy a network effect, where each new user who joins increases the value of the entire social network. For example, suppose your family members, high school class, college friends, and work associates are on Facebook. With each new person you know who joins, the network becomes much more valuable to you. Moreover, each new person you don’t know who connects to the site is a potentially new friend or associate with value.
This network effect keeps users returning to Meta’s social media properties to interact with friends, family, and acquaintances. And with 3.71 billion active global users as of the end of September, Facebook, Instagram, Messenger, and WhatsApp have more value than all of its competitors.
This vast network generates tons of valuable data fed into Meta’s new and improving artificial intelligence (AI) that’s powering content recommendations to improve engagement and is behind its ad infrastructure that boosts ad targeting. As a result of its advanced AI, Meta can counter the adverse effects of iOS privacy changes over time by doing more with less third-party data. Additionally, look for it to compete more effectively with new social media entrants through its technological prowess.
Because of Meta’s status as one of the best online ad platforms on the planet, advertisers will continue to be attracted to its social media properties. This bodes well for future revenue and free-cash-flow growth in the coming bull market.
According to Meta’s chief financial officer, the company plans to focus on efficiency and spending discipline in 2023 to increase operating income while simultaneously investing in future growth initiatives like the metaverse.
Do you believe that the company will remain frugal in 2023 and only spend money in areas with a decent probability of achieving a high rate of return? If so, now is an excellent time to invest in Meta.
Randi Zuckerberg, a former director of market development and spokeswoman for Facebook and sister to Meta Platforms CEO Mark Zuckerberg, is a member of The Motley Fool’s board of directors. Rob Starks Jr has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Apple and Meta Platforms. The Motley Fool recommends the following options: long March 2023 $120 calls on Apple and short March 2023 $130 calls on Apple. The Motley Fool has a disclosure policy.
*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.
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