Falling over 15% after earnings, was Meta unfairly beaten down?

Let's analyze Meta's performance this quarter and predict the subsequent stock price changes.

The vast majority of Meta's revenue comes from its advertising business. Driven by strong ad revenue growth, Meta's revenue in Q1 of 2024 increased by a substantial 27% year-over-year to $36.46 billion, surpassing Bloomberg's consensus expectations and marking the fastest revenue growth quarter since Q4 of 2021. Of this, core advertising business revenue was $35.64 billion, an increase of 26.8% year-over-year.

As we previously stated in our forecast, Meta's excellent performance in Q1 was largely expected, benefiting from the following factors:

In the first quarter of 2024, the U.S. economy was very strong. With an optimistic employment environment, the unemployment rate in the U.S. further declined to 3.8% in March. At the same time, U.S. consumer spending remained resilient, with March retail sales increasing by 0.7% month-over-month, with e-commerce showing the largest growth. E-commerce was the biggest driver of the company's advertising business growth this quarter, followed by industries such as gaming and entertainment.

Under strong economic support, the recovery in advertising was evident. In Q1 of 2024, the company's ad impressions increased by 20% year-over-year, and the strong demand from advertisers drove a 6% year-over-year increase in the average price per ad.

Meta owns globally renowned social media platforms such as Facebook, Instagram, and WhatsApp, holding an almost monopolistic position in the social ecosystem. With such a vast user base, in Q1 of 2024, the daily active users across the entire suite of social media applications reached 3.24 billion, marking a year-over-year increase of 7% and a quarter-over-quarter increase of 1.6%, reflecting the strong barriers of the social ecosystem. Naturally, Meta, with its massive user traffic, has become the preferred choice for many advertisers.

Meta makes full use of AI tools to improve the precision of ad recommendations while minimizing disruption to users, which is expected to enhance the monetization rate of social software (including text and video products like WhatsApp and Reels); it has launched many automated ad products for advertisers, and the scalable Gen AI ad tools have significantly increased the return on investment for ad placements. Additionally, Meta possesses the powerful open-source AI model "Llama," but it is still a considerable distance away from monetization.

In Q1 of 2024, the company's metaverse business revenue grew by 30% year-over-year to $440 million, primarily driven by increased sales of Quest headsets. However, the metaverse business remains unprofitable, with an operating loss of $3.846 billion in Q1 of 2024, which has narrowed compared to the loss in Q1 of 2023.

As an internet company with light-asset operation, Meta, during its upward cycle, will see net profit growth significantly outpacing revenue growth.

With the company's excellent cost optimization and expense control, the gross margin in Q1 of 2024 was 81.79%, which marked a notable improvement both year-over-year and quarter-over-quarter. At the same time, operating expenses only saw a single-digit increase of 4.49%, mainly due to a further decline in marketing expenses year-over-year. As a result, the company's net profit saw a year-over-year increase of 116.66% to $12.369 billion, and the diluted earnings per share (EPS) grew by 114.09% year-over-year to $4.71.

The company projected Q2 2024 revenues to be around $36.5 to $39 billion, a growth rate lower than market expectations, which led to concerns about a future slowdown in the company's performance. The doubling of EPS in Q1 2024 was significant, though one of the reasons was the substantial year-over-year decline in EPS in Q1 2023. Meta's explosive growth in EPS started in the second half of 2023, so due to the high base effect, it is very likely that Meta's performance growth in the second half of 2024 will significantly slow down, returning to a relatively stable growth level.

As we previously stated in our earnings preview, Meta's current valuation is not low, and only maintaining a very high, above-expectation growth rate can support the current stock price. If the growth rate decelerates and the company's growth prospects weaken, it could impact the stock price, potentially repeating the scenario from last week when Netflix's stock price fell after earnings.

During the earnings call, company management indicated plans to invest more in AI infrastructure over the next few years and continue investing heavily in the metaverse, with metaverse business operating losses expected to grow significantly year-over-year.

Therefore, the company substantially raised its capital expenditure forecast for fiscal 2024, expecting total capital expenditures to be about $40 billion for the year, an increase of $5 billion from the previous forecast, and far more than the $28.1 billion in fiscal 2023. Considering the growth in infrastructure investment and legal costs, the company expects total expenses for 2024 to be in the range of $96 to $99 billion, with the lower limit of the range increased by $2 billion from the previous forecast of $94 billion.

One of the important reasons for Meta's last major stock price crash was Zuckerberg's aggressive push into the metaverse, leading to an excessive erosion of free cash flow. With Meta's announcement of a major push into AI and the metaverse, it's difficult for the market not to worry that history might repeat itself. For shareholders, in the current volatile macro environment and fragile market sentiment, the tangible growth prospects of AI and the metaverse are not clear, and retaining more capital for shareholder returns would be a better choice.

So how should we invest in Meta? We can look at it from two aspects: EPS and shareholder returns:

Supported by a strong U.S. economy and a robust ecosystem barrier, the company's advertising business is expected to remain strong. However, due to the high base effect, revenue and profit growth rates are likely to slow down in the next three quarters. Therefore, the growth rate of EPS for fiscal 2024 is expected to fall significantly compared to the 73% growth in fiscal 2023.

In Q1 2024, the company repurchased $14.6 billion of its stock and spent $1.3 billion on dividends. Meta previously announced an increase of $50 billion in its buyback program on top of the existing $30.9 billion, leaving a future buyback allowance of $66.3 billion.

The company's free cash flow in Q1 2024 was $12.531 billion, a year-over-year increase of 81%. With a free cash flow of $43.847 billion in fiscal 2023, considering the significant increase in capital expenditure for fiscal 2024 partly offsetting the growth in operational cash flow, the free cash flow for fiscal 2024 is expected to be around $50 billion.

If the company maintains the buyback pace of the first quarter, it is estimated that about $40 to $50 billion could be repurchased in fiscal 2024, distributing most of the cash flow. With a market value of $1.25 trillion, the shareholder return is approximately 3.2%-4%, which is lower than the current risk-free rate of about 4.65%. The risk lies in the company reducing the buyback scale in the following quarters, resulting in a shareholder return lower than our expectations.

1. If the EPS growth rate for fiscal 2024 slows down compared to fiscal 2023 (73%) but still maintains a high growth rate of around 30%, and for fiscal 2025 and 2026, the EPS growth rate slows down to around 15%, and the free cash flow remains relatively healthy with sustainable shareholder returns. Assigning a PE (TTM) of 23-25x, the company's target price would be around $444-$483. Investors could wait for the stock price to pull back before entering, consider selling a put with a strike price below $400 to earn premiums and reduce the purchase cost; if holding the stock and being long-term bullish on Meta but expecting short-term stagnation, consider a covered call strategy to earn premiums.

2. Assuming that investments in AI and the metaverse lead to a significant increase in capital expenditure and cost expenses, causing a significant slowdown in the company's performance growth for fiscal 2024, with free cash flow being severely consumed and shareholder returns not guaranteed, then the stock price will face a significant correction. Investors could adopt a shorting strategy by buying puts.