Is Meta a Value Trap?

Is Meta a Value Trap? Initially pioneered by Benjamin Graham and later popularized by Warren Buffett, value investing is arguably the most proven and reliable approach to selecting stocks. Even value investing, though, isn’t a perfect science.

 

In some cases, stocks that look substantially undervalued by a volatile market are fairly valued. These stocks, sometimes called value traps, can be major problems for value investors.

 

Lately, some observers have questioned whether Meta (NASDAQ:META) could be one such value trap that investors should stay away from.

Before discussing whether Meta could be a value trap, let’s examine why the stock appears to be such a bargain at the moment.

 

To begin with, Meta’s P/E ratio is trading at historic lows. Today, the stock is priced at just 11.63 times earnings. Given that the ratio was over 25 even during the upheavals of 2020, it appears that Meta’s current pricing is unprecedented. These metrics are the product of Meta’s 60 percent selloff so far this year.

 

Meta has also seen its price-to-sales and price-to-book ratios drop into much more reasonable territory during this year’s selloff. The price-to-sales ratio currently stands at 3.16, and the price-to-book ratio for Meta is 3.00. These compare to industry averages of 3.56 and 3.18, respectively.

 

As such, Meta looks slightly undervalued when compared to other companies within its industry. It’s worth keeping in mind that most of these companies have seen similar selloffs to Meta during 2022.

 

A final point in Meta’s favor when it comes to value is its balance sheet. It holds no debt so its debt-to-equity ratio makes it resilient to rising interest rates and economic instability. Meta also generated $4.95 in free cash flow per share last quarter, giving it a modest but still positive FCF ratio.

 

By most standards, Meta appears to be undervalued at its current price. A discounted cash flow forecast suggests that the stock is likely worth about $236, more than 70 percent above the current price of $136.

 

The median analyst forecast for the next 12 months is slightly lower at $215, reflecting an upside of 57.7 percent. Even if these projections are significantly too optimistic, the stock could turn a handsome profit for investors who buy in while the price is low.

 

The first indication that Meta could be a value trap is its slowing user base growth. In the most recent quarter, the company’s core Facebook platform expanded its user count by just 1 percent.

 

This strongly suggests that the company’s historic growth driver is likely very near maturity. While Facebook can still make improvements around the edges, the days of revolutionary innovation and exponential growth from the social media platform are likely over.

 

Turning to one of Warren Buffett’s favorite investment standards, it appears that Facebook could be losing its moat as competition in the social media market heats up.

 

TikTok is by far the biggest threat to legacy social media companies, accounting to some extent for Meta’s slow growth in the first quarter. While Meta’s Facebook and Instagram platforms are still dominant, it’s clear that the company’s competitive advantage isn’t ironclad.

 

Underlying these other issues is Meta’s future earnings growth potential. At present, analysts expect the company to deliver an anemic growth rate of 4.9 percent over the next five years. Given that this is less than a third of the growth rate over the past five years, it strongly appears that Meta is in for a dramatic slowdown.

 

Ultimately, there are reasonable arguments on both sides of the issue when it comes to Meta being a value trap. Zero debt, positive cash flows and a mature, proven advertising platform all suggest that Meta could be undervalued.

 

On the other hand, it’s also clear that Meta’s growth could slow considerably in the coming years. Between this slower growth and increased competition, there’s a chance that Meta could see lower revenues and earnings.

 

In this scenario, Meta would likely be valued fairly at today’s prices and could see its share prices stagnate going forward.

To some extent, Meta’s future also hinges on the metaverse technology it is currently focused on building. Reality Labs, the company’s metaverse division, has lost over $22 billion as it invests in the technology that could one day power virtual worlds.

 

If these investments bear fruit, the company could regain its footing in terms of growth. CEO Mark Zuckerberg believes that the metaverse could become a completely new economy in which 1 billion people eventually spend hundreds of dollars each year. If this view is correct, the current investments in metaverse technology could one day pay excellent dividends.

 

If the investment in Reality Labs don’t put Meta back on track in terms of growth, though, they will represent a large amount of misallocated capital.

 

The money spent on Reality Labs could also be used to develop social media products to compete with TikTok or make basic improvements to Facebook and Instagram. As such, a significant amount of Meta’s growth potential is still up in the air.

 

Even taking this into account, however, it’s likely that Meta is at least somewhat undervalued. While slower growth and reliance on unproven technology are concerning, Meta still has an extremely valuable social media business that generates massive annual revenues.

 

Given the company’s lack of debt, Meta appears less risky than several of the other high-growth tech stocks that have faced similar pressures this year.

 

In the long run, investors can likely expect a decent recovery followed by slow, steady growth from Meta. The company appears to have matured, meaning that blistering growth and massive valuation multiples will no longer be part of the stock’s dynamic.

 

The core business, however, remains sound. Facebook and Instagram are still dominant social media platforms with room to gradually grow their earnings. As such, it’s difficult to argue that Meta is truly a value trap.

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