Meta Platforms (META) is scheduled to release its Q2 earnings on July 31, after the closing bell. While the company is anticipated to deliver robust double-digit growth in both revenue and earnings, investor’s reactions may depend on the capital expenditures outlook, which is likely to draw significant attention. Given the historically volatile aftermath of Meta’s earnings reports (see the image below), Q2 might be no exception. Even though I’m a long-term holder of Meta, I’m keeping a neutral stance on the company’s shares ahead of Q2.
In this article, I’ll explain why Meta’s Q1 all-around beat didn’t impress investors and why betting on the stock before Q2 might be a risky move.
What Went Wrong for Meta in Q1?
Meta Platforms has been on a roll with its trading performance over the past year, but things took a dive after its Q1 earnings report. The stock fell more than 10% once the results were released (see the late-April drop in the chart below).
In Q1, Meta reported a 27% year-over-year revenue jump to $36.46 billion, beating market expectations of around $36.15 billion. Given that almost all of Meta’s revenue comes from ads, it solidified its position as the fastest-growing Big Tech company online. For comparison, Amazon’s (AMZN) ad business grew 24% in Q1, while Google’s (GOOGL) grew by about 13%.
On the earnings front, Meta also beat estimates with an EPS of $4.71, while analysts were expecting around $4.32. This impressive result was largely due to Mark Zuckerberg and his team’s effective cost management, which led to a 91% year-over-year increase in operating income.
So why did the market react so negatively in Q1? It boils down to these few key issues:
- Light revenue guidance: Meta’s revenue forecast for Q2 is $36.5 billion to $39 billion. The midpoint of $37.75 billion, which would be an 18% year-over-year growth, fell short of analysts’ average estimate of $38.3 billion.
- Rising capital expenditures (CapEx): Meta revealed that its CapEx is expected to be between $35 billion and $40 billion this year, up from the previous range of $30 billion to $37 billion. This increase is due to investments in infrastructure to support their AI initiatives, including the open-source large language model Llama. The high spending surprised investors and made Meta the biggest spender on AI hardware among Big Tech companies.
Adding to the concern, the last major sell-off of META stock happened in 2022 when Meta announced significant increases in spending on metaverse projects and other investments, which are not directly tied to their core revenue source — ads.
This past experience left investors wary, especially since Meta had been expanding its margins after years of high spending and recently reduced its workforce by about 20%. During the Q1 earnings call, the stock took a hit when CEO Mark Zuckerberg talked about his long-term focus on the Metaverse and investments in augmented reality (AR) glasses, like the Ray-Ban Meta glasses. This renewed emphasis on non-ad-related projects further unsettled investors.
Why Q2 Might Still be Riskier Than Expected
Despite the negative reaction to Meta’s Q1 earnings, the stock rebounded over the next few months, trading close to $540 per share at one point. This recovery reflects more cautious optimism on Wall Street, which is looking forward to a potentially positive full year and Q2.
Considering Meta’s midpoint revenue projection for Q2, this would mean a 20% increase — a big drop from the 27% growth seen last quarter. Investors should be aware that Q2 2023 marked the beginning of a significant recovery in advertising for Meta, so comparisons should be be tougher this time around.
Over the past three months, 34 analysts have raised their EPS projections for Meta, while 18 have lowered them. For revenue, 31 analysts revised their projections up, and 24 revised them down. Overall, the consensus seems balanced and not overly bearish.
However, the real focus for investors should be on Meta’s CapEx spending in Q2. CFO Susan Li mentioned that although the company doesn’t provide guidance beyond 2024, capital expenditures will continue to rise next year due to ongoing aggressive investments. This could be risky. If Meta reports further increases in CapEx guidance, it might rekindle investor skepticism, at least in the short term.
On the positive side, Meta’s forward P/E ratio is 24x, which is only ~5% above its five-year average. Additionally, when comparing EPS with the long-term growth estimate of three to five years CAGR, Meta’s forward PEG ratio is 1.34x, about 11.5% below its historical average.
In my view, these valuation multiples seem relatively derisked and make sense, given Meta’s heavy investments in AI likely converging into more earnings upfront and its strong ad revenue growth leadership position compared to its Big Tech peers.
Is META Stock a Buy, According to Analysts?
Wall Street analysts don’t appear concerned about Meta’s stock performance. The consensus rating is a Strong Buy. With 44 analysts covering the stock, only three have a Hold recommendation, and just two have a Sell recommendation. The average Meta Platforms stock target price is $538.95, indicating upside potential of 10.1% based on the most recent share price.
The Takeaway
Meta is set for another strong quarter, which will likely beat both revenue and earnings expectations. The Big Tech giant has been working hard to improve its margins by significantly cutting costs over the past couple of years. The big question for investors in Q2 will be CapEx projections. Given Meta’s recent history of problematic investments in areas that don’t directly drive revenue, there’s some skepticism about how their spending strategy will turn out.
Even if Meta does well this quarter, if CapEx is in line with expectations, the stock might react positively. Still, I think betting on that right now is a bit risky. Personally, I’d rather focus on Meta’s long-term potential. As a major player in the tech world, it’s well-positioned to benefit from its heavy investments in AI down the road.
