I am neutral on Meta platforms (NASDAQ:META) is one of the largest social media and technology companies in the world. I think it is probably overvalued because of the market’s enthusiasm for Meta’s new focus on efficiency and profitability.
While I believe management’s tighter focus on profitability is a positive for the company going forward, it is still likely to face challenges in revenue growth, which will have a significant impact on its ability to grow its bottom line. Therefore, I believe the stock could see some downside volatility in the near term due to its high valuation.
The year of efficiency gains comes to an end
Meta stock has gained 78.5% over the past 12 months. This increase is mainly due to the strong results achieved after Meta’s “efficiency year.” For example, the company’s net income for the fourth quarter of 2023 increased by 204% compared to the fourth quarter of 2022. However, these results are largely the result of short-term cost reductions, including 20,000 layoffs, as opposed to long-term growth drivers. These efficiency gains cannot be sustained indefinitely despite the promise of AI and automation.
Given the nature of these recent gains, Meta’s valuation has, in my view, potentially become too high. Historical growth rates in GAAP earnings and free cash flow are unlikely to be sustained. Management delivered GAAP earnings growth of 73.11% and revenue growth of 39.11% over the past year on the strength of the year. However, Meta’s revenue growth over the next five years and beyond is unlikely to exceed its five-year historical average of 22%, in my view.
AI and Automation Factors
As I mentioned, AI and automation are a big part of Meta’s investment for the future. The company should be able to maintain its revenue growth rates thanks to AI-powered advertising and generative AI (like the LLama 3 extended language model and Meta AI assistant). However, this is a double-edged sword in the short term, as the company will spend up to $40 billion on AI by 2024.
These investments are undoubtedly essential for the company to remain competitive, but in the short term, the effects on the company’s cash flow and profitability are likely to impact the stock price. Moreover, remaining competitive in the AI space will be capital intensive in the long term, which is likely to reduce both profitability and revenue opportunities in the near future until its AI infrastructure has a more reliable moat.
Potentially overvalued
Despite Meta’s strong long-term growth trajectory, I believe that in the near term, there is likely to be a correction in its price as its growth rates normalize and medium-term market expectations become more moderate. The stock currently has a price-to-sales ratio of 9.15x, which is 23.60% higher than its five-year average of 7.40x. Additionally, 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 given the current valuation. If the price were lower, Meta would seem to me to be a great long-term investment. But given the current high price-to-sales ratio, I am skeptical about capital allocation, as the valuation significantly reduces the long-term returns I am likely to achieve.
Given that the company’s revenue is not expected to continue growing as it has in the past, I believe 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 year over the period, the stock price would be around $1,260, implying a price CAGR of around 8.8%, since current revenue per share is $55.67 and the current stock price is $540.
Is Meta Stock a Buy, According to Analysts?
On Wall Street, Meta has a Strong Buy consensus rating based on 37 Buys, three Holds, and two Sells assigned over the past three months. At $527.68, Meta’s average price target implies a downside potential of 2.3% over the next 12 months.
In my opinion, I think the potential for negative returns over the period has been underestimated by analysts. Given that I am looking for a minimum return of 10% and more over 12 months, Meta stock seems worthy of a Neutral rating.
Takeaway: Meta-assets present a valuation risk
Meta’s long-term outlook remains strong as management continues to build a moat in AI infrastructure. The company’s ability to begin automating more advanced enterprise tasks also opens the door to profitability gains. Additionally, the company’s recent dividend issuance is a positive for long-term shareholders.
However, in my view, valuation risk is high at present. As a value investor, I seek to buy quality growth stocks at a reasonable price. I find it unlikely that Meta stock is fairly valued and certainly not undervalued at current levels, based on my analysis and research.
Disclosure
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