I am neutral on Meta Platforms (NASDAQ:META) stock, one of the world’s most prominent social media and big tech companies, at the moment. I think it is likely overvalued due to enthusiasm in the market for Meta’s new focus on efficiency and profitability.
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While I believe management’s more stringent profitability focus does present strength for the company moving forward, it is still likely to face challenges with revenue expansion, significantly impacting its ability to expand its net income. As a result, I think the stock could experience near-term downside volatility based on its high valuation.
Year of Efficiency Gains Are Ending
Meta stock has gained 78.5% over the last 12 months. Primarily, this has been driven by strong results following Meta’s “year of efficiency.” For example, the company’s net profit for Q4 2023 increased by 204% compared to Q4 2022. However, these results have largely been the result of short-term cost reductions, including 20,000 layoffs, as opposed to long-term growth factors. These efficiency gains cannot be kept up forever despite the promise of AI and automation.
Due to the nature of these recent gains, in my opinion, the valuation of Meta has potentially become too high. Historical growth rates in GAAP earnings and free cash flow are unlikely to be maintained. Management has achieved 73.11% GAAP earnings growth and 39.11% revenue growth over the last year as a result of the year of efficiency. However, revenue growth for Meta over the next five years and beyond is unlikely to expand much from its historical five-year average of 22%, in my opinion.
AI & Automation Factors
As I touched on, AI and automation are a big part of what Meta is investing in for its future. The company is likely to be able to work to maintain its revenue growth rates through AI-powered advertising and generative AI (such as the LLama 3 large language model and the Meta AI assistant). Still, this is a double-edged sword in the near term because the company is spending up to $40 billion on AI in 2024.
These investments are undoubtedly crucial for the company to stay competitive, but in the near term, the effects on the company’s cash flow and profitability are likely to have an impact on the stock price. In addition, staying competitive in AI will be highly capital-intensive over the long term, which is likely to reduce both profitability and revenue opportunities in the immediate future until its AI infrastructures have a more reliable moat.
Potentially Overvalued
Despite Meta’s strong long-term growth trajectory, in the near term, I think there is likely to be a correction in its price as its growth rates normalize and the market’s medium-term expectations become more moderate. Currently, the stock has a price-to-sales ratio of 9.15x, which is 23.60% higher than its five-year average of 7.40x. In addition, its GAAP price-to-earnings ratio is 29.36x, which is 11.37% higher than its five-year average of 26.36x.
I think some caution is warranted because of the valuation at the moment. If the price were cheaper, Meta would look like an excellent long-term investment to me. But at the present high price-to-sales ratio, I am skeptical about allocating capital because the valuation reduces the long-term returns I am likely to achieve significantly.
Because the revenue of the company is unlikely to continue to grow as it did historically, I think that the price-to-sales ratio is likely to contract over the next decade. If the ratio is around 7x in 2034 and revenue grows at a rate of 12.5% per annum over the period, the stock price would be approximately $1,260, implying a price CAGR of approximately 8.8%, as the current revenue per share is $55.67 and the current stock price is $540.
Is Meta Stock a Buy, According to Analysts?
Turning to Wall Street, Meta has a Strong Buy consensus rating based on 37 Buys, three Holds, and two Sells assigned in the last three months. At $527.68, the average Meta stock price target implies 2.3% downside potential in the next 12 months.
In my opinion, I think that the potential for negative returns over the period has been understated by analysts. Because I am looking for a minimum of 10%+ returns over 12 months, Meta stock looks worthy of a neutral rating to me.
The Takeaway: Meta Has Valuation Risk
The long-term outlook for Meta remains strong as management continues to build a moat in AI infrastructure. The potential for it to begin automating more advanced enterprise tasks also opens up room for profitability gains. In addition, the company’s recent issuance of a dividend is a benefit for long-term shareholders.
However, in my opinion, the valuation risk is high at this time. As a value investor, I am looking to buy quality growth stocks at a reasonable price. I find it unlikely that Meta stock is fairly valued and certainly not undervalued at present levels based on my analysis and research.
