Meta Platforms Inc.'s (META, Financial) ride up from the bottom it saw in 2022 has been nothing short of a fairy tale story for the company, its investors and its management. The company has come off its lows with one of its strongest performances in its recent fourth quarter. Meta has demonstrated incredible resilience in pivoting from its ill-fated singular gamble on the metaverse to re-focusing on its core strength: online ads. The fourth quarter of 2023 has also shown how the company used its Year of Efficiency to adopt a lean, strategic approach to long-term secular growth.
However, my valuation model suggests markets are getting ahead of themselves while overstating the growth outlook for Meta. In my opinion, the strong outperformance in its earnings has led to outstretched valuation multiples. I think it would be prudent for investors to wait for a pullback before investing in the stock.
Earnings recap
Meta's recently released earnings report emphatically outperformed on all levels. The social media giant's fourth-quarter revenue rose 25% year over year to $40.11 billion, beating expectations by over 2%. For the year, revenue rose 16% to $135 billion. I believe the strong sales beat was driven by a continued rebound in its online ad business, which can be seen in the chart below.
From the chart above, I note how Meta's ad revenue jumped 25% on a year-over-year basis. Most of the growth in ad revenue was driven by increased spending in regions such as Europe, up 33%, and Asia Pacific, up 22.50%, while advertising revenue in the U.S. grew 18.50%.
What is more interesting to me is the surge in revenue in Meta's Reality Labs division, which saw its biggest quarter yet, crossing $1 billion in revenue. This means that in addition to strong growth in its ad business, Meta also had some momentum starting to build in the sales of its mixed reality headsets, such as Quest and Ray-Ban smart glasses. However, the operating losses in the Reality Labs division widened to $4.60 billion due to expenses increasing 15% in this division. Management guided for a further meaningful increase in expenses within Reality Labs in 2024. While this could act as a deadweight for the company from a margin standpoint, I expect the sustained momentum in its overall ad business to continue to pull the company ahead and offset the losses in the Reality Labs division.
On the earnings front, Meta's net profits more than tripled from a year ago to $14 billion, or $5.30 in earnings per share. As such, the company beat earnings expectations by over 7%. As if these results were not enough to entice the markets, Meta also announced it will begin rewarding investors with a 50 cent dividend, which, on an annualized basis, works out to a roughly 0.50% yield. On top of that, the company announced a $50 billion buyback.
I believe Meta decided to reward its investors with buybacks and its first ever dividend because fiscal 2023 was a monumental year where its cash and cash equivalent items grew a massive 61%.
Ad platform saw wider adoption with new AI and automation tools
So far, management has demonstrated its ability to reassess priorities and build on its business strengths to return cash to shareholders. According to my analysis, I believe Meta was well positioned to do so because management turned its attention back to reinvigorating growth in its core online ads business rather than continue to deploy resources solely toward building the metaverse.
In my opinion, the key to monitoring Meta's future growth expectations will come from watching trends in its ad metrics, such as ad impressions and prices paid per ad. My reasoning is that it is primarily an ad-based business, with ads being served across its social media platforms. While monitoring user growth is an important indicator that suggests higher potential reach per ad on Meta's social networks, over time the efficiency of the ad targeting came into question.
However, Meta was able to drive innovative changes to its ad tools to provide marketers with better ways to target users on its platforms, increasing the relevancy of ads served to its users. With the proliferation of artificial intelligence last year, Meta has become a frontrunner in the space by launching many open-source machine learning models. But on a more immediate basis, I observed how the company demonstrated agency by rapidly deploying AI capabilities into its ad tools for its enterprise customers, offering higher productivity.
In August 2022, the company launched Advantage , which allowed advertisers to automate many steps of the ad creative process, thus optimizing ad campaigns for marketers on the platform. Through the months that followed, Meta followed up with its innovation strategy by infusing AI into ad-based tools to further improve productivity for its marketers and customers.
I believe these improvements have been critical in driving improvements in ad impressions, as can be seen in the chart below. Ad impressions increased 21% on a year-over-year basis. I think this a significant performance in its ad business given the company already demonstrated strong growth in its ad impressions in the same quarter last year.
The augmentation that I see in the ad dynamics, as seen in the chart above, also tells me how Meta is a huge beneficiary of the trends above. I have added another chart below that shows that Meta's revenue from its ad business was up almost 24% in the most recent quarter.
On the fourth-quarter earnings call, management also noted how businesses have been leveraging messaging apps to directly connect with their consumers. I have attached some commentary from the call below that illustrates this:
"Meta is continuing to invest in new and engaging on-platform ad experiences. Business messaging remains a priority here. Click-to-message ads continue to grow and we're seeing advertisers increasingly use these ads to drive down-funnel conversions. Paid messaging is growing quickly and we're focused on broadening adoption in 2024 by making it easier for businesses to buy marketing messages, easily adopt our Flows product to develop richer in-thread experiences for consumers."
Allowing businesses to purchase paid messaging ads and click-to-message ads broadens the scope of the ad impressions metric that we saw earlier in this section, which is monumental in driving higher advertising revenue growth for the company. In emerging markets such as India, many businesses have already started adopting broadcast messages to connect with consumers. This adds further support to my argument that paid messaging could be an immediate revenue driver for Meta this year.
Valuation looks stretched for now
Unfortunately, despite all the positive developments in Meta's core ad business, my valuation models suggest investors have gotten too optimistic. After the earnings beat, I have assumed the higher end of the consensus estimates for the company's 2024 revenue and earnings. My non-GAAP operating income estimates also include management's guidance on costs and expenses, which they currently project at between $94 billion and $99 billion. Moreover, management expects to fill its employee recruiting backlog while still keeping the organization lean. Therefore, I have assumed an average share float over the past three years of 2.67 billion in my valuation model.
Taking these assumptions into account, I estimate Meta will grow its operating income at a compound annual rate of 13.30%, driven by increased efficiencies in its ad business and higher productivity from deploying AI capabilities across its ad tools. My models show investors have fully priced in Meta's growth for this year on the basis of the results and commentary from Meta's Q4 FY23 report.
Risks and other factors to consider
The single biggest risk to Meta's growth outlook hinges on the global gross domestic product outlook. The IMF currently projects the world's GDP will rise 3% in 2024. I believe the U.S., India and China to be important contributors to the world's GDP. These regions are also important for Meta's business. For example, Meta Chief Financial Officer Susan Li added in her prepared remarks that “Meta benefited from strong demand by advertisers in China reaching people in other markets," while also mentioning that “revenue from China-based advertisers represented 10% of our overall revenue."
Chinese e-commerce companies like Shein and PDD-owned (PDD, Financial) Temu have been investing their ad dollars heavily into Meta's ad platforms throughout 2023. If the pace of ad business from Chinese e-commerce companies materially slows down, this could be a slight headwind to Meta's business. Moreover, if the growth outlook for any of these regions or the global GDP outlook were to deteriorate, the company's revenue would be severely impacted due to lower ad spend on its platform.
In addition to the global GDP outlook risks, many countries that are core to Meta's business also have elections this year. India will have its elections in May, followed by the U.S. elections at the end of the year. This may cause some volatility in the stock.
Finally, Meta has a history of facing regulatory headwinds from sovereign authorities on a global scale. The FTC is still pursuing an antitrust case accusing the company of suppressing competition. If the FTC wins its case, it may have a significant impact on Meta's business and financial results.
Conclusion
There is no doubt Meta has enjoyed the success of achieving a turnaround in its ad business while also benefiting from improving growth outlooks in the U.S. and global economy. I am encouraged by the efficiency that management has demonstrated. However, the company's share price seems to have already priced in optimism from its fourth-quarter results.
