The FAANG stocks consisting of Facebook parent Meta Platforms Inc. (META, Financial), Amazon.com Inc. (AMZN, Financial), Apple Inc. (AAPL, Financial), Netflix Inc. (NFLX, Financial) and Alphabet Inc.'s (GOOG, Financial)(GOOGL, Financial) Google were previously thought to be untouchable by the market mayhem. In 2022, however, these stocks have faced a series of detrimental headwinds, driven by a combination of macroeconomic factors and company issues.
In this discussion, I will break down the financials from advertising giants Meta and Google, which recently announced their results for the third quarter of 2022.
Meta Platforms
Formerly known as Facebook, Meta Platforms (METS) owns the world's most popular social media platforms: Facebook, Instagram and Whatsapp. The company announced mixed financial results for the third quarter on Wednesday.
Revenue of $27.71 billion fell 4% year over year, but still beat analysts' estimates by $314 million. Sales were mainly impacted by foreign exchange headwinds caused by a strong U.S. dollar. International revenue on a foreign exchange-neutral basis would have actually increased by 2% year over year.
Meta Platforms makes the majority of its revenue from advertising, which is impacted by two main factors.
First is overall advertising spending, which is based heavily on the macroeconomic environment and consumers' propensity to buy products. In this case, the high inflation and rising interest rate environment has caused many analysts to forecast a recession. Customers are seeing their energy costs rise (driven partially by the Russia-Ukraine war) and the higher interest rates mean higher debt servicing costs. Overall, this means less excess money in the pockets of consumers and fear-driven stagnation. Advertisers usually decide to pull back advertising spend during these times as they wait to see how the macroeconomic situation unfolds. In this case, this has acted as a headwind against Meta’s revenue and further impacts are expected in the fourth quarter. However, the holiday season should offset some of this.
The second major factor that impacts advertizing revenue is if Meta Platforms still has the attention of its users, as that is the commodity that is monetized. In this case, the family of apps which include all its social media platforms had 3.71 billion monthly active users in the third quarter, which increased by 4% year over year. Rival TikTok is believed to be impacting growth rates as the platform surpassed 1.2 billion monthly active users at the end of 2021.
To compete with the popular short-form video platform, Meta developed its Reels video format. The feature is achieving over 140 billion views each day, up a staggering 50% in the trailing six months. However, the company is struggling to monetize the feature, which is impacting quarterly revenue by approximately $500 million. The good news is Meta is investing in improving the monetization ability of Reels and is expecting vast improvements within the next 12 months.
Earnings disaster
Meta’s earnings per share fell 49% from $3.22 in the third quarter of 2021 to just $1.64 in the most recent quarter. The decline was driven by a combination of factors, including Reels monetization issues as well as a 19% increase in operating expenses.
Metaverse
CEO Mark Zuckerberg is investing between $10 billion and $15 billion per year into the "Metaverse," the company's latest venture. The idea is to connect people in a realistic and more immersive manner through the power of virtual reality and augmented reality.
At the Meta Connect event earlier this month, Zuckerberg showcased a state-of-the-art AR wristband that could be used to control smart glasses without the need for a mobile device. In past podcasts, shared that his smartphone has reached its limit in its current form factor, so a new computing platform is required. The Metaverse is still unproven and investors are skeptical, but the potential is huge.
Valuation
The recent headwinds have caused Meta’s share price to plummet. The stock fell approximately 20% in pre-market trading after the earnings announcement alone. The good news is the stock is currently deeply undervalued as Meta trades with a price-earnings ratio of 10.2, which is 59% cheaper than its five-year average. To put things into perspective, the stock trades at a similar price to 2015 despite revenue being 10 times higher.
The GF Value also indicates a fair value of $386 per share based on historical ratios, past financial performance and analysts' future earnings projections. Therefore, the stock appears to be signficantly undervalued at the time of writing.
Alphabet
Alphabet's (GOOG, Financial)(GOOGL, Financial) Google is the world's most dominant search engine and an advertising juggernaut. The company generated $69.1 billion in revenue during the third quarter, which increased by only 6% year over year. This slow growth relative to history (40% in 2021) was driven heavily by foreign exchange rates. On a foreign exchange-neutral basis, revenue would have increased by 11% year over year.
Like Meta, Alphabet is facing a slowdown in revenue growth due to the macroeconomic climate and a pullback in advertising spend.
Alphabet makes approximately 90% of its revenue from advertising, so it is heavily influenced by this industry. The good news is that, historically, advertising spend has been cyclical and the company still maintains its dominant search position.
The company also owns the world's most popular mobile operating system, Android, in addition to video platform YouTube. YouTube is currently facing similar issues to Meta with regards to monetizing its new Shorts format, which is the equivalent of Reels and TikTok videos. However, the good news is this is not a core part of Alphabet's overall business and, therefore, is not as large of an issue. Despite this, the YouTube Shorts format has over 30 billion daily views and 1.5 billion users per month.
Earnings review
Alphabet saw its operating expenses increase by an eye-watering 26% year over year to $20.8 billion. This was driven substantially by investments in its data centers and headcount growth. The company also spent heavily on sales and marketing as it announced new product releases such as the Pixel 7.
Due to these factors, earnings per share of $1.07 missed analysts' expectations by 19 cents.
Cloud growth driver
As the fastest-growing part of the business, Google Cloud is Alphabet's secret weapon. This segment produced revenue of $6.9 billion in the third quarter, which increased by nearly 40% year over year. Google Cloud is the third-largest cloud infrastructure provider globally and, despite being behind Amazon Web Services and Microsoft Corp.'s (MSFT, Financial) Azure, the platform has huge growth potential due to the digital transformation trends.
Valuation
Alphabet trades with a price-earnings ratio of 20.10, which is about 25% cheaper than its five-year average.
The GF Value indicates a fair value of $141 per share, which means the stock is significantly undervalued at the time of writing.
Final thoughts
Both Meta and Alphabet are innovative technology companies that are facing a series of headwinds.
I believe Meta faces the most challenges as the business has a lot of fundamental issues. In addition, the Metaverse is an unproven concept and will require huge capital expenditure.
Alphabet's Google is a much safer bet in my eyes as the company is still in a dominant position and is just experiencing cyclical advertising headwinds, which historically have bounced back. Google's self-driving vehicle unit, Waymo, is also gaining traction and recently launched in Los Angeles.
Both stocks are undervalued overall, but Alphabet appears to be the safer long-term bet.
