Meta's Aggressive Spending and AI Strategy: A Double-Edged Sword for Growth

Meta: Spending Aggressively, Growing Just As Quickly (NASDAQ:META)

Even after the YTD rally, the stock trades at a reasonable ~21x P/E. I'm reiterating my buy rating with a $600 price target (~17% upside). It has been a fairly bleak earnings season for the stock market, including and especially for the tech stocks that have powered this year's sharp rally. Yet amid carnage, one of the few bright spots this quarter is Meta (NASDAQ:META), the social media company. Earlier this year, Meta faced pressure as it increased its spending outlook for the year, citing a desire to get ahead of the AI investment curve (which, by the way, is an important driver to be bullish on other companies in the infrastructure ecosystem, such as memory ship vendors and networking providers). Investors have seemingly gotten over Meta's spending plans and focused on its growth rates, which are vastly outstripping its boosts in spending. Year to date, Meta has hung onto a ~50% year to date gain: I last wrote a bullish note on Meta in May, when the stock was trading in the mid-$470s. Since then, the stock has crept up further alongside a strong Q2 earnings print. I am reiterating my buy position for Meta, though the jittery stock market (and the fact that Meta's appeal vis-a-vis other falling tech stocks has fallen in relative terms) has me on the lookout for a near-term exit point. The first point to note alongside Meta's Q2 earnings print: the company updated its outlook yet again for factor in greater planned spending on capex. While it comes as a small relief that the company held its full-year opex (largely headcount expense) outlook at $96-$99 billion, it yet again boosted its capex spending plan to $37-$40 billion, which is $2 billion above the low end of the company's prior $35-$40 billion range, and well above the first outlook it gave at the end of Q4'23 of $30-$37 billion in capex spending. All of this is driving increased infrastructure investments to support AI features. Moreover, the company warned that while it's not providing any concrete figures yet, it's expecting FY25 opex levels to expand substantially driven by larger depreciation and amortization costs from this year's capitalized investments into infrastructure. But as I argued in my prior article on Meta, investors should be willing to forgive Meta's higher spending on account of its top-line growth rates - to which excitement over AI features have contributed. Now, across the company's portfolio of applications, the search bar functions automatically default to a Meta AI query. Since rolling these features out, Meta has continued to see daily active users climb alongside ad impressions - so it's safe to say that Meta's spending is yielding fruit and establishing its position as a leading AI engine. Meta's Q2 results amply justify why the stock rallied in the wake of broad-based weakness among other tech peers. Take a look at the Q2 results below: Revenue grew 22% y/y to $39.07 billion, blasting past Wall Street's expectations of $38.31 billion (+20% y/y). We do note that revenue growth did decelerate slightly from 27% y/y growth, which was driven in part by a deceleration in ad impressions served - a metric we'll have to watch closely in the coming quarters. We'd think that across the world, the Meta "Family of Apps" (as the company calls it) has reached a near-saturation point, and yet the company continues to add daily active users each quarter. As shown in the chart above, Family DAPs reached a record of 3.27 billion, adding 30 million net-new daily active people within the quarter. Where we will have to watch receding trends, however, is in ad impressions: which slowed from 20% growth in Q1 to 10% y/y growth in Q2. This deceleration was felt globally, with the company's largest revenue-generating region (the U.S. and Canada) seeing impression growth rates cut in half to 8% versus Q1, and similar trends playing out in Europe, Asia, and the rest of the world. We do note that at least in the U.S., there will be a positive catalyst in the back half of the year in the form of U.S. election-based traffic, which tends to drive both increased online activity and more vigorous advertising from campaigns. But even in the early innings of election-based messaging, Meta is benefiting from boosted ad pricing. Globally, average price per ad impression grew 10% y/y, accelerating from 6% growth in Q1 and helping to blunt the impacts from softer ad impressions growth. We particularly like the fact that Asia has reversed several quarters of weaker ad pricing and returned to 4% y/y growth, while the Rest of World led the pack with 24% y/y growth: an important metric as this segment has the lowest ARPU among all of Meta's geographic segments. Also important to note: CEO Mark Zuckerberg noted on the Q2 earnings call that the company is noticing increased traction with young adults, which it defines as the 18-29 age bucket. As this segment will continue to drive the lion's share of advertising dollars as they age, this is a very positive long-term trend for Meta: We estimate that there are now more than 3.2 billion people using at least one of our apps each day. The growth we're seeing here in the US has especially been a bright spot. WhatsApp now serves more than 100 million monthly actives in the US, and we're seeing good year-over-year growth across Facebook, Instagram, and Threads as well, both in the US, and globally. I'm particularly pleased with the progress that we're making with young adults on Facebook. The numbers we are seeing, especially in the US, really go against the public narrative around who's using the app. A couple of years ago, we started focusing our apps more on 18 to 29 year olds and it's good to see that those efforts are driving good results. Another bright spot is Threads which is about to hit 200 million monthly actives. We're making steady progress towards building what looks like it's going to be another major social app. And we are seeing deeper engagement, and I'm quite pleased with the trajectory here." We note as well that Meta continues to see generous gains in profitability: As shown in the chart above, operating income dollars leaped 58% y/y to $14.8 billion, while operating margins saw nine points of y/y improvement to 38%. Capex spending year to date has grown "only" 13% y/y, which is more than justified by Meta's much larger corresponding increases in profits. It may come as a surprise to many investors that even after this year's sharp rally, Meta still trades at reasonable valuations. For next year FY25, Wall Street analysts are expecting Meta to generate $183.8 billion in revenue (+14% y/y) and $24.14 in pro forma EPS (also +14% y/y). At current share prices near $515, the stock trades at a 21.3x FY25 P/E (or 20.6x P/E on an ex-cash basis, adjusting for the company's $45.8 billion of net cash on its most recent balance sheet). Meta is in-line with the broader S&P 500, despite its superior growth rates. Still, I'd be ready to cash in on recent gains (with an eye to re-buy at a lower price) if the stock hits a 24x FY25 ex-cash P/E, indicating a price target of $600 for the company and ~17% upside from further levels. Until then, stay long on this stock but keep a close eye on further gains.

Meta Continues To Crush The Market And Shares Could Continue Outperforming (NASDAQ:META)

Despite risks, Meta delivered a strong Q2 earnings beat, with revenue up 22.1% YoY and net income increasing by 72.89% YoY. Meta Platforms (NASDAQ:META) is having an outstanding year as shares are up 46.28% YTD compared to the S&P 500 being up 12.04%. There is always something happening with META that spooks the investment community. Whether it's lawsuits, scandals, Mark Zuckerberg testifying on the hill, spending on the Metaverse, or spending additional capital on AI, there are always bears trying to amplify a negative narrative. When shares of META were freefalling in 2022 and crashed below the $100 level, I was adamant that the fundamentals were strong, and that the selloff was unjustified. On 11/1/22, I wrote an article about META's massive upside potential (can be read here), and since then, shares have appreciated by 448.89% compared to 37% for the S&P 500. I am just as bullish now as I was then. I haven't sold any shares, and I believe META will continue going higher. META continues to see growth across its platforms as more than a 1/3 of the global population utilizes one of its products. The election cycle is starting to heat up, and I believe we will see an influx of add dollars flowing to the bottom line. META is in a prime position to shape the narrative on AI and benefit at scale from companies and individuals getting a better ROI on their advertising dollars. META continues to rebound after earnings, and I believe shares are headed to all-time highs in the fall of 2024. In my last article about META, which I wrote on 4/29/24 (can be read here), I had discussed why the meltdown from around $525 to $430 was unwarranted. Regardless of whether you don't utilize their products or agree with Mark Zuckerberg, it's hard to deny that they are one of the best companies in the world when looking at their market cap, revenue generated, and profits produced. After smashing Q2 earnings, I wanted to follow up with a new article to discuss how I believe META will shape a segment of AI, and why I see shares continuing to all-time highs. For years, I have heard that META is losing its relevancy, but time and time again, this narrative is proved incorrect when the updated user counts and top-line revenue are announced. I think shares of META are going higher, and even at the $500 level, shares look inexpensive on a forward basis. Despite being one of the largest and most profitable companies in the market, there are always risks to investing, even when discussing META. At some point, user growth will plateau, and engagement could decline. META depends heavily on ad revenue, so if we see declines in engagement, META may not be able to charge as much as they do for ads, and we could see less demand for their advertising services. There are always privacy and regulation concerns, and it's entirely possible that new legislation is crafted that negatively impacts META's buisness. Realty Labs continues to lose money, and while the losses are embedded within a large pool of profitability, some investors look at this as recklessness and don't trust Mark Zuckerberg to be a steward of shareholder capital. There are also competitive risk factors, such as new products capturing engagement and taking away ad dollars that were previously allocated toward META or companies such as Alphabet (GOOGL), Amazon (AMZN), or TikTok providing additional ROI on ad campaigns. META has many different types of risks, and investors should be aware of the potential headwinds that could materialize in the future. For anyone who thought META was losing a step, they're not. What could arguably have been the most impressive aspect from earnings was that META added 30 million daily active people (DAP) over the past 3 months. There are currently 8.17 billion people globally, and META added 0.37% of the global population to their platforms in Q2. On a daily basis, 40.03% of the global population uses one of META's products. Profitability aside, no other company that I know of has this type of global reach. When I think about the value added for anyone who is looking to deploy an advertising budget, META is at the top of the list. By adding 30 million DAPs in Q2, META increased its total DAPs by 7% YoY, and the number of ad impressions across the META ecosystem increased by 10% along with the price per ad. META's average revenue per person increased by 14.11% YoY in Q2 from $10.42 to $11.89. In addition to the 10% global increase per ad, META recognized an 18% increase in ad pricing across Europe and 24% in the rest of the world category. The global growth in DAPs and ad cost continues to positively impact META, and despite what anyone is saying, META just produced its 2 largest quarter for revenue as they added $7.07 billion (22.1%) YoY in Q2 to their top-line. META delivered a large top and bottom-line beat in Q2 as they came in with $39.07 billion in revenue, which was ahead of the consensus estimates by $760 million. META grew its revenue by 22.1% YoY in Q2. META also generated $5.16 in GAAP EPS, which was a $0.40 beat on the bottom line. The reason why I continue to give Mark Zuckerberg the benefit of the doubt is because META continues to increase margins and profitability for shareholders, despite his forward-thinking around expenses. In Q2 2024, META increased its total costs expenses by 6.68% YoY to $24.22 billion. By spending an additional $1.62 billion, META was able to produce an additional $7.07 billion in revenue YoY, which was an 18.1% jump compared to the $32 billion in revenue they generated in Q2 2023. META also drove in $14.85 billion in income from operations, which was a 36.74% increase YoY as they added an additional $5.46 billion. META also expanded its operating margin by 8.65% to 38%. As a shareholder, I am extremely happy and applaud META's operating proficiency, as all these financial accomplishments cost an additional $1.62 billion. After income taxes and all their other expenses, META's net income in Q2 grew by $5.68 billion or 72.89% YoY to $13.47 billion. There were 13 weeks in Q2 2024, and META generated $1.04 billion in net income per week, which is a metric not many companies can compete with. While Mark Zuckerberg was criticized for all the CapEx spending on the Metaverse, he was able to redeploy compute from GPUs toward AI. META is currently in an AI arms race, and he wasn't shy about discussing spending. He specifically indicated on the earnings call that the amount of compute needed to train the Llama 4 model will be roughly 10x what was needed for Llama 3, and future models would need additional compute. Susan Li specified on the earnings call that META anticipates that the bottom range of their previous CapEx guide of $35 - $40 billion would increase to $37 billion, and they are planning on CapEx growth in 2025 to support AI research and development. These are big numbers, but I look through the Cash Flow Statements before I form an opinion. Last year, META spent $27.27 billion on CapEx but generated $71.11 billion in cash from operations, which allowed them to produce $43.85 billion in free cash flow (FCF). In the trailing twelve months (TTM) META has allocated $28.88 billion toward CapEx and generated $78.42 billion in cash from operations. Even if META generates $80 billion in cash from operations and spends $40 billion on CapEx in 2024, they will still produce $40 billion in FCF. As an investor, I don't see a problem with this, considering that META is spending money on building their future and expanding its moat without tapping the debt markets. When I listen to Mark Zuckerberg discuss his vision on how META will not only compete but be a winner take most in the new age of computing, I agree with the CapEx allocation. At the end of the day only a handful of companies will be able to compete with META because just about every company outside Apple (AAPL), Microsoft (MSFT), Amazon (AMZN), and Alphabet (MSFT) doesn't have the balance sheet or profitability to keep up with META from building out the compute to training the models. This will allow META to shape how AI performs, and provide better products and features to its clients. Their recommendation models will get more advanced, and META will be able to fine-tune every customer's needs when it comes to reaching their desired demographic. Mr. Zuckerberg went as far as to say that in the future, a client will be able to just give META a budget and business objective, and they will take care of everything else on the backend. The other big aspect was AI Studio, which had just been launched. This lets anyone create AI to interact with across their products. Individuals or companies will be able to utilize META's AI Studio to generate AI agents, which will be able to create content, interact with individuals within their community, and answer their questions. META is also testing its business AI and getting feedback. When I think about the use cases for these products and how this could add to META's top and bottom line, I get very excited. While other companies may be able to provide similar enhancements in the future, many of the ecosystems that individuals are interacting with are on META's platforms. META is just going to make their mousetrap better and more profitable. META is putting itself in a position where they will continue to be a dominant player in the online space, and paying for additional AI services from META will be critical for businesses to unlock more potential from their social media presence. Before getting into the actual valuation, I wanted to highlight that META is still growing despite a slight setback in 2022. Over the past 10 years, META has grown its revenue by 1,101.54% ($137.32 billion) as its increased to 149.78 billion in the TTM. Its gross profit has increased by 1,083.55%, while operating income increased by 1,136.12% and net income grew by 1,649.46%. On a YoY basis, in the TTM, META has grown its revenue by $14.88 billion (11.03%), gross profit by $13.16 billion by 12.09%, operating income by $11.53 billion (22.96%), and its net income by $12.34 billion (31.55%). In addition to continued growth across many of the critical line items on an income statement, META has also expanded its profitability margins. In 2014, META finished the year with a 82.73% gross profit margin, 40.06% operating margin, and 23.58% profit margin. In the TTM 10 years later, META's gross profit margin has declined by -1.24% to 81.49%, but they grew their operating margin by 1.15% to 41.21% and their net income margin by 10.75% to 34.34%. More than 1/3 of every additional dollar generated of revenue hits the bottom line, and that is something most companies can't achieve in addition to the level of revenue and profitability META produces. In addition to looking undervalued, META is still growing and isn't just on the defensive trying to protect what they have built. When I look at META on a forward basis, I get excited. META is expected to generate $21.20 of earnings this year, placing its 2024 forward P/E at 24.42. I compared META to the rest of the Magnificent Seven, in addition to Home Depot (HD), Walmart (WMT), and The Coca-Cola Company (KO) to add some perspective outside of big tech. Based on 2024 earnings, META trades at the 4 lowest level as Alphabet (GOOGL), HD, and KO trade between a P/E of 21.39 and 24.10. When I look out to 2025 and 2026, META trades at the 2 lowest P/E level in both categories at 21.43 times 2025 earnings and 18.70 times 2026 earnings. META has 30.61% earnings growth on the horizon from the close of 2024 through 2026, which is double HD and KO, yet it trades at a lower multiple on forward earnings. I think META looks extremely cheap at this valuation. I also look at META on a free cash flow (FCF) basis, because I like to have confirmation to my valuation thesis from another profitability metric. I like FCF because it's harder to manipulate than net income, as it's simply cash in vs cash out. META is trading at 26.44 times its FCF, as it would take a little less than 27 years for META to generate its entire market cap in FCF. The only company that trades at a lower valuation is HD, and we know that META is on a spending spree to build its AI infrastructure. KO trades at 32.69 times its FCF, and the rest of big tech trades at over 30 times its FCF. I think that the price to FCF metric further validates that META is undervalued. I am going to make some predictions that might not come true, but I think shares of META have the potential to finish near $575 in 2024 and $700 by the end of 2025. If META was trading at $575 right now, it would still trade at less than 30 times earnings for 2024 and at 20.77 times 2026 earnings. I believe that META is going to outspend most of the competition and create more value for its clients through new product features that will enhance its advertising efforts and make its businesses more effective across social media platforms. The large spending on hardware and ramping up AI features could spawn a new era of growth for META, and I think the next several years could be very lucrative for shareholders. As a long-term shareholder, I am very excited about the future and think that META looks inexpensive on a forward basis.

Meta Platforms Stock: AI Strategy Is Correct, But There's No Free Lunch (NASDAQ:META)

This idea was discussed in more depth with members of my private investing community, Tech Cache. Learn More " If there's one company I've talked about over the last year outside of Nvidia (NVDA) capable of capitalizing on the use of AI, it's been Meta Platforms (NASDAQ:META). The company set course from the beginning to open source its LLM (large language model), immediately setting it apart from the other major players like Google (GOOG)(GOOGL) and Microsoft (MSFT), which both kept their LLMs closed source (OpenAI in Microsoft's case). This strategy has allowed Meta to provide an advanced generative AI model capable of, first and foremost, enhancing its money-making product: Ads. This resulted in it taking digital advertising market share over the last year from Google, only bested by Amazon (AMZN), as the latter expands its ad business. With its Q2 report, Meta plans to increase its AI investments heavily in 2025 to further this strategy. The problem is the free run on expenses is ending as it laps those initial capex purchases through depreciation, and running all those Nvidia (NVDA) AI accelerators will add up in ongoing operational costs. Make no mistake - Meta Platforms is one of the best major tech companies utilizing AI and not seeing it turn to vaporware as merely an AI chatbot or some search assistant for pure novelty. It's pointing the firepower toward recommendation systems to keep its users more engaged with content, along with better targeting of its ads and, more importantly, ad results and metrics back to advertisers. It has only recently pushed out Meta AI for day-to-day users of its platforms, doing things in reverse of other major tech companies. This has proven to be successful. First, it has paid off in terms of revenue growth while reducing headcount by 8.2% from Q1 '23 to Q2 '24. While you can read into the chart below on many different levels - both rightly and wrongly - the idea is the company was able to grow revenue while doing it with fewer employees. This isn't something you typically see. Generally, headcount reduction is to save on expenses while the company grapples to keep revenue growth existing - it comes at the cost of future product revenue. This is a different picture altogether from Meta because it had different reasons than most companies for executing layoffs (see: Intel (INTC)). On a two-year revenue growth look (something I've been tracking for Google and Snap (SNAP) also), Meta comes out on top while Google continues to accelerate slowly, and Snap sees ad revenue flatline as Snapchat+ makes up the difference (these revenue numbers are actual ad revenue, not total revenue for each company). When investors and analysts ask about "seeing ROIC for AI," these two charts should appear next to the answer. It's early days, but there's already a payoff for the investment Meta has seen in AI. Much of it has to do with its work pre-ChatGPT era, but it had the right solution when it came time to kick on the afterburners and install the H100s en masse. This was unlike many other large tech companies, where adding jet fuel to a broken engine didn't make their products fly. When you have this kind of success with a strategy, particularly with AI, growing those investments is the right one and is exactly what Meta shared on its Q2 call. We expect that having sufficient compute capacity will be central to many of these [AI] opportunities, so we are investing meaningfully in infrastructure to support our core AI work, in content ranking and ads, as well as our generative AI and advanced research efforts. Our ongoing investment in core AI capacity is informed by the strong returns we've seen, and expect to deliver in the future, as we advance the relevance of recommended content and ads on our platforms. While we expect the returns from generative AI to come in over a longer period of time, we are mapping these investments against the significant monetization opportunities that we expect to be unlocked across customized ad creative, business messaging, a leading AI assistant, and organic content generation. - Susan Li, CFO, Meta Platforms' Q2 '24 Earnings Call This is where the 2024 and 2025 dollar investments come in to maintain and advance the AI strategy. We anticipate our full-year 2024 capital expenditures will be in the range of $37-40 billion, updated from our prior range of $35-40 billion. While we continue to refine our plans for next year, we currently expect significant capex growth in 2025 as we invest to support our AI research and our product development efforts. - Susan Li, CFO, Meta Platforms' Q2 '24 Earnings Call There are two things here - well, three, if you consider the strategy itself. The first is the investments to this point have come essentially "free" and haven't materially impacted expenses. This is mainly because it has been able to use the tailwind of lower headcount while there's a lack of infrastructure depreciation. The second is 2025 will now see these operational and depreciation expenses hit while also piling on even more significant expenditures toward it. Obviously, there's no getting around it: These significant investments require ongoing costs and will depreciate just like any other infrastructure. The difference is headcount has now moderated and may even tick up slightly for higher-skilled positions needed to support the investments. So while the company has been enjoying the "masking" (and I use that term loosely - this is just a natural part of the strategy of investing heavily while reducing headcount) of its additional AI expenses, it's now going to not only see an increase in expenses but not have any expense reduction strategy to counter it with. It essentially becomes a double whammy just through timing. This sets up 2025 for a difficult comp in revenue growth and expenses after reducing them dramatically in 2023 and growing them lightly in 2024. You can already see expenses are set to grow faster than revenue by Q4 before starting the lapping of this year. This is based on the company's guidance for expenses of $98B at the midpoint for FY24. This will pressure margins and be a headwind to bottom line growth, though it's happening from a much better baseline than 2022's bloated company structure. In this regard, the company is entering a higher expense season from a better position than it did previously while executing the correct strategy to keep it efficient with its ongoing AI development. However, this may keep the thumb on shares (impact sentiment) and prevent them from seeing new highs over the next few quarters, even as the ROI has been proven through lowered headcount and greater revenue growth these last several quarters. The upside potential comes in if the company can re-accelerate growth after lapping a strong 2024 through these continued investments. This mainly comes from ad impressions and ad pricing. If these metrics can remain strong year-over-year, revenue will follow. As of right now, revenue growth estimates for FY24 are for ~20% growth, with FY25 estimating 13.5% growth. If the company can see stronger growth, much closer to 18%-19% for FY25, the stock may fare better. This timing issue isn't even in Meta's control, really. It has to spend and then operationalize its AI strategy, so it's going to feel a pinch at some point. But it's better to do it from a leaned-out workforce than a bloated one. To make this continued AI spending worthwhile, it needs to continue seeing better efficiency improvements and further strength in its ability to target ads, surface content, and generate a positive feedback loop. If it can do this, barring a recession in the next few quarters, it could be the best-positioned major tech stock in the market. However, this doesn't preclude the stock from seeing a consolidation and perhaps another move down to the low $400s over the next few months, as the coming expense "weight" likely impacts sentiment. If it does, I'll reevaluate the risk-reward and analyze the stock chart for signs of bottoming. For now, I keep it at a hold.