Meta Platforms: Navigating AI Investments and Market Volatility

Meta Stock: Achieving These Types Of Returns Never A Straight Path (NASDAQ:META)

Meta's strategic investments in AI, particularly the Llama 3.1 model, and robust advertising revenue growth position it well for future success. We are pleased to report that Meta Platforms (NASDAQ:META), our largest position in the fund, has delivered a remarkable performance, +450% since our November 2022 note. Our investment in Meta dates back to 2018, with an average cost basis of approximately $172 per share. Today, the stock trades around $535, reflecting a 3x return over the six-year holding period, equating to a 20% annualized return. We would like to remind you that achieving these types of returns is never a straight path. From time to time, we might experience volatility - that's simply part of the investment journey. In fact, wealth creation and volatility go hand in hand. There's no escaping it; it's the "price of admission" the market demands. If you take a look at the chart below, you'll notice the drawdowns META stock has faced over the years, with 2022 standing out as a particularly challenging period, where the stock saw a 75% drop. However, if we were to tune out the market's volatility (and the emotions that inevitably come with it) and focus solely on the fundamentals of the business with a long-term perspective, the results are quite impressive (see key performance data below). Over the course of our six-year ownership, the growth in revenue, earnings, and free cash flow per share closely mirrored the strong returns we achieved from the stock. We were pleased with Meta's robust progress in its financial and strategic position. There are now 3.27 billion people that use at least one of their apps each day. In Q2, Meta achieved a 22% year-over-year increase in revenue, reaching $39.07 billion, and net income rose by 73% to $13.47 billion, surpassing analyst expectations. Key to this growth is their significant investment in artificial intelligence, particularly with the development of their Llama 3.1 model. CEO Mark Zuckerberg envisions Meta AI as potentially the most used AI assistant globally by year-end, although monetization will take time. AI integration has also bolstered their advertising revenue, which grew to $38.33 billion, demonstrating its effectiveness in optimizing their core business. Their "Family of Apps" core business posted a $19.3 billion operating profit in the quarter, which resulted in a very impressive 50% operating margin - we don't often come across businesses that put up those kind of margins. The company has also increased its capital expenditure forecast to $37-40 billion, underscoring its commitment to AI infrastructure. We believe that Meta's strategic focus on AI and open-source initiatives positions it well for future success. Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.

Concerned About An AI Bubble? Meta Platforms Remains A Top Pick (NASDAQ:META)

Looking for a portfolio of ideas like this one? Members of Best Of Breed Growth Stocks get exclusive access to our subscriber-only portfolios. Learn More " I am growing increasingly convinced that Meta Platforms (NASDAQ:META) is undisputedly the top pick among mega-cap tech. The company might not be growing the fastest or trading at the lowest valuation, but may very well be the dark horse in the generative AI race. Looking under the hood shows that the stock might be even cheaper than it looks when adjusting for Reality Labs losses. I expect the stock to re-rate higher over the long term as the market shows greater appreciation to not only the growing network effects of Facebook and Instagram, but also the growing dominance in online advertising afforded by the company's heavy investment in artificial intelligence. I reiterate my strong buy rating on the stock. I last covered META in May, where I stood by the stock in spite of Wall Street's then-skepticism surrounding the company's aggressive investment in CapEx spending, which had sent the stock plunging after first quarter results. The stock has jumped nearly double-digits since then. With markets near all-time highs, it can be tempting to disregard META as just another over-crowded trade, but to me, it looks more like a diamond in broad daylight. META's second quarter results confirmed the new reality: this is a company that has found a balance between above-market revenue growth and committed profitability gains. META saw revenues grow 22.1% YoY to $39.1 billion, exceeding the high end of the guidance range of between $36.5 billion and $39 billion. The Family of Apps ('FoA') business notably generated a 50.4% GAAP operating margin, up from 41.6% a year prior. Inclusive of $4.5 billion in Reality Labs' operating losses, the company posted a 38% consolidated operating margin. In spite of the heavy investment in the metaverse, the company remains one of the most profitable companies in the tech sector and the market overall. META saw its daily active people number tick slightly higher at 3.27 billion. With Facebook having crossed its 20th anniversary this year, investors should focus less on the modest user growth and more on the company's ability to continue building upon its vast social networks even at this large scale. Instead, the bulk of revenue growth was driven by gains in average revenue per person, which grew 14.1% YoY. The company has impressively been able to sustain 10% YoY growth in ad impressions delivered, as well as a 10% jump in price per ad. As seen in the numbers, the company's efforts to use artificial intelligence to power its content feeds makes it one of the biggest AI winners - despite the stock seemingly often being left out from discussions of top AI stocks. META ended the quarter with $58 billion of cash versus $18.4 billion of debt, representing a bulletproof net cash balance sheet. The strong balance sheet and profit margins allowed the company to repurchase $6.3 billion in stock and pay out $1.3 billion in dividends, which was still lower than the $10.9 billion in free cash flow. Looking ahead, management has guided for the third quarter to see up to $41 billion in revenue, implying growth of 20% YoY at the high end. That is an impressive guide given that the third quarter of 2023 was widely viewed to see comparables get much tougher as the company had seen growth slowdown mightily in 2022. Management raised the low end of 2024 CapEx from $35 billion to $37 billion and continued to outline expectations for even higher investments in 2025. It took some time, but I think that Wall Street is becoming increasingly comfortable with the idea that META is a real artificial intelligence play. On the conference call, management outlined expectations for a future in which advertisers can just provide a "business objective and a budget" and they will be able to do the rest for them. I have already been impressed by the work that this company has done to use AI to power their content feed generation, but it is possible that even I have not been optimistic enough. Just 2 to 3 years ago, the market was concerned about META's long-term relevancy, as the platform appeared to be challenged by both competition (TikTok) as well as technological constraints (data privacy changes by Apple). The company's heavy investment in artificial intelligence to power their content feed generation has clearly helped it overcome these obstacles, but also creates a new paradigm: the strongest social network of the future might be dependent not only on the network itself but also the technology backing it. Social media has historically had the "fad risk" - whereas in the past I might have been concerned about hearing younger generations say that "TikTok is cooler," I am now of the view that META's superior technological advances are a moat in itself. As META works towards making it even easier for advertisers to advertise on the platform, we reach this positive feedback loop in which META appears to be the platform that will earn the greatest resources to invest in technological innovation, as well as having the top-tier talent and willingness to make such investments. META is beginning to look very much like Amazon (AMZN) looks in e-commerce through its heavy logistics investment. But it doesn't stop there - management is not just patting themselves on the back and declaring success on their AI investments. Management has explicitly noted that generative AI is not yet a meaningful driver of revenue, but that they expect a "solid return" over the long term. This is a situation in which the company has already reaped great benefits from their AI investments but continues to invest aggressively to become a future leader in generative AI - be it through chatbots or the uncertain future. As of recent prices, META was trading at just around 24x earnings. That valuation looks more than reasonable considering consensus estimates for just around double-digit top-line growth moving forward. I am of the view that META deserves to trade at a 30x earnings multiple, similar to Apple (AAPL) but representing some discount due to the relatively faster growth. That valuation would be justified by the strong net cash balance sheet and dominant market position. But the stock looks quite cheap even without this assumption. The Reality Labs segment holds back earnings by around 30%. If one values META on a P/E basis, this would be assigning a negative value to that segment. Yet as a new owner of the Meta Ray-Ban Smart Glasses, I am of the view that the market may be drastically underestimating this segment, which has seemingly been often dismissed as just a money-losing pet project. If we instead value the segment at $0, then the stock may be offering at least 30% potential upside to a 24x earnings multiple. But there may be even more to be optimistic about here. As mentioned earlier, the FoA business has an enviable 50% GAAP operating margin. I see these margins moving higher. If META can execute against its ambitions to allow fully automated ad generation, then it may benefit from both increasing advertising demand as well as higher potential for cost discipline. META stock looks very attractive here with 30% multiple expansion potential on top of 15% annual shareholder return potential (between revenue growth and the earnings yield and, importantly, inclusive of Reality Labs' losses). TikTok competitive risks have not been taken seriously for quite some time, but may re-emerge in the future. As witnessed in 2022, META has exposure to the macro environment - its secular growth story has matured to the point that secular growth might not always be enough to offset a macro slowdown. I expect the company to remain one of the most profitable companies of any sector even in a market downturn (or perhaps, especially in a market downturn), but the stock may nevertheless experience volatility. It is possible that consensus estimates prove too optimistic - the company, after all, is operating at a $160 billion revenue run-rate. It is possible that regulators enact laws that damage the business, perhaps aiming to reduce screen-time for minors. That might be the most underappreciated risk - META might end up being "the new tobacco." META looks like a definitive winner in the generative AI arms race. The company has already reaped the benefits of AI in its content feed generation, which has helped it to use technological advances to fend off competition. Investors might be concerned about a potential AI bubble, but META stock looks attractively priced for what it is today, while offering compelling upside if the company can continue executing against a generative AI future. Investors might also be underestimating the potential for the Reality Labs segment, which might end up becoming more than just a cash drain on the business. I reiterate my strong buy rating for the stock.

Meta Platforms: AI Spending Fully Supported By Strong Business Momentum (NASDAQ:META)

This idea was discussed in more depth with members of my private investing community, Outperforming the Market. Learn More " Meta Platforms (NASDAQ:META) continues to show why it should be a core holding within portfolios, with its core business thriving and growing profitably, enabling the company to have ample excess cashflow to direct towards future growth opportunities. I have written extensively about Meta on Seeking Alpha, which can be found here. In the prior article, I highlighted that I saw that engagement trends continue to move in the right direction, contributed by the AI recommendation engine and Reels, and that I also believe that Meta is in a position of strength to invest today to become a leading player in AI in the future. In this article, I continue to have the view that Meta is moving in the right direction to become a leading player in AI in the future. Meta Platforms financials continue to be in a position of strength. Total revenues in 2Q24 increased 23% on a constant currency basis to $39 billion, beating consensus by 2% By contrast, total expenses only increased 7% from the prior year to $24 billion, expanding the margin profile of the company. When looking at the expenses by specific line items, cost of revenue increased 23%, R&D increased 13%, marketing and sales decreased 14% and G&A decreased 12%. The higher cost of revenue was due to higher infrastructure and Reality Labs inventory costs. The higher R&D cost is due to higher headcount costs and infrastructure costs. The lower marketing and sales and G&A costs were due to lower restructuring costs, headcount costs, and legal costs. As can be seen below, cost of revenue as a percentage of revenue stayed the same at 19% from the prior year, while R&D, sales and marketing and G&A as a percentage of revenue fell from 29%, 10% and 13% to 27%, 7% and 9% respectively. Operating margin for 2Q24 increased from 29% in the prior year to 38% in 2Q24. 2Q24 operating income beat consensus by 3%. Net income came in at $13.5 billion, representing EPS of $5.16 per share, beating consensus by 9%. Capital expenditures for 2Q24 came in at $8.5 billion, largely due to the investment in servers, data centers and network infrastructure. Free cash flow of $10.9 billion was generated in 2Q24. Meta Platforms bought back $6.3 billion in shares and paid shareholders $1.3 billion in dividends in the quarter. As of end 2Q24, Meta Platforms still had $58 billion in cash and marketable securities. Next, we look at the two segments of Meta Platforms. Firstly, Family of Apps revenue grew 22% from the prior year to $38.7 billion. Within Family of Apps ad revenue, the largest contributor to growth were the online commerce vertical and gaming and entertainment, and media verticals. From a geography perspective, ad revenue growth was the strongest in the Rest of the World and Europe, which saw ad revenue grow 33% and 26% respectively on a user geography basis. The number of ad impressions and average price per ad both increased by 10% in 2Q24. Ad impression growth was driven by Asia Pacific and Rest of World. The average price per ad growth was driven by strong advertiser demand due to better ad performance. Meta Platforms also reported Family of Apps other revenue grew 73% from the prior year to $389 million, which was driven by business messaging growth from WhatsApp. Expenses for a Family of Apps were up 4% in 2Q24, up 4% largely due to higher infrastructure and headcount costs, offset by lower restructuring costs. That said, the strong revenue growth of 22% more than offset the 4% increase in expenses for a Family of Apps. As a result, Family of Apps operating income came in at $19.3 billion, or a 50% operating margin, up from 41% a year ago. Secondly, for Reality Labs, revenue increased 28% from the prior year to $353 million, largely due to sales of Quest headset. Reality Labs operating loss came in at $4.5 billion, as expenses for Reality Labs grew 21% from the prior year to $4.8 billion, largely due to headcount cost and inventory costs. For the third quarter, management continues to see healthy advertising demand on its platform as a result of growing engagement and improvements to ad performance. Revenue for 3Q24 is expected to come in between $38.5 billion and $41 billion, ahead by consensus by 2% at the midpoint. Expenses for 2024 were reiterated to be between the range of $96 billion to $99 billion. The guidance for capital expenditures for 2024 has increased at the low end, from the earlier range of $35 billion to $40 billion to the new higher range of $37 billion to $40 billion. In turn, management shared that in 2025, capital expenditures will grow significantly to support its AI research and product development efforts. Management did not provide quantitative guidance for 2025, but they expect infrastructure costs to drive expenses growth in 2025 due to depreciation and operating costs of the AI infrastructure buildout. CEO Mark Zuckerberg made it clear that the compute power needed to train Llama 4 is likely to be 10x more than what was used for Llama 3, which was trained on 16k H100s. This does mean that capital expenditures are likely to remain elevated for the next few years, given that the future models are Llama 4 will likely require even more compute. To drive the Family of Apps business going forward, Meta Platforms has two main levers it can pull to drive revenue growth: Delivering engaging experiences for its users, and effectively monetizing that engagement with time. Firstly, to improve on engagement, Meta is focused on two areas in particular, the first is video and the second is to improve on in-feed recommendations. Within Instagram, as Meta Platforms continues to make enhancements to its recommendation systems, Reels engagement continues to grow. This includes efforts to increase more discoverability within Instagram so that content from emerging creators can find its way to more users. Within Facebook, the company has seen encouraging early results after rolling out its unified video player and ranking systems globally, which brings all video types into one viewing experience for the user, and Meta Platforms has intentions to increase the mix of shorter videos over time to improve engagement. One encouraging sign for Facebook is the increase in Facebook usage for 18- to 29-year-olds in the US, led by Groups and Marketplace. I think it is good to see encouraging results after the company started to focus its apps more on this age group a few years ago. Within WhatsApp, management also has seen encouraging signs of improving retention and engagement, which has coincided with some statistics for Meta AI, where India is its largest market for WhatsApp and also become its largest market for Meta AI usage. In addition, in the US, WhatsApp now has more than 100 million monthly active users. Within generative AI, management highlighted that Meta AI has seen some encouraging momentum with engagement, as more than a billion queries have passed through Meta AI since it was first introduced. The company is launched more new features within Meta AI to improve engagement. Within Threads, as the company improves on its content recommendation systems and launch new features, the Threads community continue to improve on engagement and grow. Threads is soon to reach 200 million monthly active users, another significant milestone for the very young app. Secondly, to effectively monetize engagement, Meta Platforms continues to optimize the level of ads and enhance marketing performance. On the former, there are still opportunities to grow the number of ads on lower monetizing surfaces like video. More importantly, it is not about the quantity of ads, but also the quality of the ads. Meta Platforms has increasingly been able to differentiate itself by becoming better at determining the best ads to show users and when to show them so that it leads to the best conversions. On the latter, through improvements in AI, management is starting to see AI being increasingly useful to improve marketing performance, after adopting some advancements including its Meta Lattice ad ranking architecture, which led to improved ad performance in 2Q24. It is not just about improving marketing performance, but it is also about making it easier for advertisers to automate their campaign setup with its Advantage+ suite of products. In fact, US advertisers that used Advantage+ saw 22% higher return on ad spend, based on a study the company did. Meta Platforms continue to see advertisers adopt these tools, and it continues to add more features, including generative AI ad features. Since launching its first generative AI ad features, background generation, text generation and image expansion capabilities, Meta Platforms has seen more than 1 million advertisers use at least one of these new features in the last month. The topic of capital expenditure efficiency remains a key one for all big tech companies, including Meta Platforms. I have mentioned this before and I will state here again that Meta Platforms has two buckets of AI investments, core AI and generative AI. Core AI is currently in a more mature stage where management can see strong returns on investment in terms of engagement and ad performance, and it continues to be an area of investment for Meta Platforms. Generative AI is in a much earlier stage and given generative AI products are unlikely to generate meaningful revenues in the near-term, it is not possible to measure near-term returns on investment in this bucket. That said, the payoff from this investment in the generative AI bucket will be in the long-term and management expects this to not only be solid revenue opportunities but expects this to also open new revenue opportunities for the company. As such, within the core AI bucket, the investments in this bucket are informed by the strong returns that are expected in the future as it helps improve engagement and ad performance of the Family of Apps business. While the returns from the generative AI bucket will take time to materialize, the company is mapping the investments in capital expenditures in this bucket to the significant monetization opportunities they bring. This means that a dollar of investment into GPUs could be mapped to Meta AI, which is then expected to have a significant future payoff. Another thing to note here is that there is flexibility in terms of the use of these investments. This means that the AI infrastructure that was meant for generative AI training can then be used for either generative AI inference, or even its core ranking and recommendation workloads. Management also remains focused on improving the cost efficiency of its workloads as well. The key for Meta Platforms is that having sufficient compute capacity will be key for the company in most of its current and future opportunities. While Reality Labs has taken a backseat due to AI, it remains a long-term investment for the company. While these investments are made, Meta Platforms is also focused on operating the business more efficiently. At the end of the day, Meta Platforms is run by CEO Mark Zuckerberg, and what he says about AI spending will determine the trajectory of the spending in the area. In particular, while Mark Zuckerberg admits it is hard to predict how this trend will continue after multiple generations of Llamas, at this point, he would rather "risk building capacity before it is needed rather than too late, given the long lead times for spinning up new inference projects". In essence, better to be early and spending more, rather than late and not having any capacity at all. Before updating my valuation numbers, I am revising my financial forecasts for Meta, particularly in the near-term. In 2024, I have revised the revenue and EPS figures marginally to reflect the beat in the quarter. In 2025, I expect a smaller margin expansion than in 2026, in part due to the impact of the significant investments made in 2025 to grow its AI research and product development efforts. As such, while I expect Meta to gradually expand operating margins to 45% in the long term, which is slightly below its pre-pandemic operating margin of between 45% to 50%. My intrinsic value for Meta is $583, assuming a 25x terminal multiple and 11% cost of equity. For reference, Meta has a 5-year average P/E of 25x, and given that Meta's competitive position and fundamentals are the best it has been and still improving, I think this multiple is justified. My entry price is thus $432, based on a 20% discount to the intrinsic value to provide sufficient downside protection. My 1-year and 3-year price targets for Meta are revised upwards to $618 and $836 respectively. The 1-year and 3-year price targets imply a 25x 2025 P/E and a 25x 2027 P/E, which, I think, is reasonable based on the historical P/E range of Meta. Meta has a 5-year average P/E of 25x, as highlighted above, which, I think, is reasonable given where its competitive position and fundamentals are today. I think the 2Q24 quarter showed Meta Platforms continue to have a solid business model, seeing improvements in engagement across its platforms and ad performance improvements driving the business going forward. Given the strong margin expansion as a result of operating leverage and strong revenue growth, free cash flows have been strong as well, meaning that the company has more than sufficient financial resources to invest in current and future business opportunities. While the debate about capital expenditures will likely continue, I think the company showed that the investments in near-term core AI will continue to see high returns on investment, while the longer-term investment in generative AI will open up new revenue opportunities and sizeable business opportunities for the company in the future.