Will Meta Recover: Alphabet Earnings Offer A Clue

Will Meta Recover? In some ways, it came as a shock when Meta (Facebook) announced that thousands of employees would be laid off. Though all of the major players in the tech industry have lost value in 2022, most investors and analysts assumed the pain was temporary. After all, Meta is one of the greatest tech success stories of all time.

Founder and CEO Mark Zuckerberg was a college student when he came up with the idea for Facebook, and in less than 20 years, he built one of the most valuable brands in the world.

In June 2021, Meta’s market cap topped $1 trillion for the first time, and nearly half the world’s population had a Facebook account. A quarter of the world logs into the social media site at least once a day.

Things changed after the pandemic was brought under control. Post-COVID, the economic cards stacked up against Meta and the rest of big tech. Meta’s market cap is now below $300 billion.

Investors are anxiously looking for signs of recovery but finding none. Alphabet’s gloomy earnings report escalated their anxiety, and the question everyone wants answered is what Alphabet’s terrible earnings mean for Meta.

Why Did Alphabet Stock Go Down?

When Alphabet announced its third-quarter results, the news was nearly all bad.

Revenue, operating income, and earnings per share came in below their targets, which were already relatively low, given the headwinds predicted during the second-quarter earnings call.

Revenue increased just six percent to a total of $69.1 billion when estimates called for $70.6 billion. Operating income was down 19 percent for a total of $17.1 billion, and earnings per share declined to $1.06 – a substantial drop over third-quarter 2021’s $1.40 per share. The disappointment was compounded by the fact that analysts predicted earnings per share of $1.25.

Alphabet stock lost 6.6 percent in after-hours trading following the earnings announcement, and a little over a week later, prices hit a 52-week low of less than $84 per share.

Year-to-date, Alphabet stock is down more than 33 percent, which is a bit of a shock after impressive gains in 2021 and the first quarter of 2022.

The trouble that Alphabet faces is heavy reliance on advertising dollars. Yes, the company brings in some revenue from Google Cloud and other divisions, but ultimately, everything but the advertising segment is losing money.

Google dominates the search engine market worldwide, making it the most powerful digital advertising platform available. It raked in cash that was used to fund emerging projects.

Inflation, rising interest rates, and the threat of recession have prompted marketing departments to reign in digital advertising expenses, directly impacting Alphabet’s top and bottom-line results.

Alphabet’s leadership team doesn’t expect an immediate turnaround – economic conditions are simply too volatile to make those sorts of promises – but the company is planning measures to reduce expenses in light of the drop in revenue. For example, in the third quarter of 2022, Alphabet increased its staff by 25 percent – an enormous cost. That won’t be repeated in the fourth quarter.

The hope is that historical advertising patterns will repeat, making this a normal part of a standard cycle. During previous economic challenges, including the global financial crisis and the COVID-19 pandemic, marketing budgets tightened for a short period, but the change was temporary. In both cases, Google’s advertising business recovered relatively quickly.

If the pattern repeats, now is a perfect time for investors to buy Alphabet stock at a bargain price. Of course, there is some risk. Share prices may decline further or stay low for an extended period if the larger economy continues to struggle.

But what does all of this have to do with Meta stock?

Why Is Meta Stock Falling?

Meta stock lost more than 66 percent of its value year-to-date, and the third-quarter earnings report didn’t help. At all. The company announced its third-quarter results on October 26, 2022, and share prices immediately dropped roughly 25 percent.

The decline wasn’t due to a single miss or an isolated issue. There are concerns across the board. Essentially, revenue is down, expenses are up, and there was no clear plan to turn those numbers around. Worse still, leadership indicated that the fourth quarter is unlikely to deliver meaningful improvement. In fact, current guidance indicates revenue will go down by seven percent compared to the fourth quarter of 2021.

Meta’s third-quarter revenue totaled $27.7 billion, slightly exceeding analysts’ $27.4 billion target. However, that’s not quite a win when it represents a four percent year-over-year drop following a one percent year-over-year drop in the second quarter. If the seven percent decrease expected for the fourth quarter materializes, full-year results will be pretty dismal.

Meanwhile, despite declining revenue, Meta’s expenses are going up to the tune of a 19 percent year-over-year increase. That reflects poorly in the company’s operating margin. In the third quarter of 2021, the operating margin was 36 percent. For the third quarter of 2022, it is down to 20 percent.

Earnings per share totaled $1.64 for the quarter, which was a miss compared to analyst estimates of $1.89. With leadership suggesting that expenses will continue to rise in 2023 and no indication that revenue will keep up, it’s no surprise that Meta stock went down considerably.

After the disastrous earnings call, Mark Zuckerberg announced that 12.6 percent of Meta’s workforce would be laid off. That translates to big savings from an expense perspective, and Meta stock saw a little jump.

Some investors are betting that Meta can turn things around and go on to deliver tremendous growth in the coming years. Others aren’t quite ready to make that bet, considering the uncertainty surrounding Meta’s future revenue stream.

Facebook and Instagram users don’t pay for access to the social media platforms. Instead, they share personal information that allows marketers to reach their intended demographic. The social media sites make money from advertising revenue, and they can charge premium rates given the precision with which an audience can be targeted.

Investors are concerned because fewer users are logging into Facebook and other Meta platforms. At the same time, marketing budgets have been slashed based on economic conditions, which impacts Meta in the same way it impacts Alphabet.

The drop in advertising could be temporary, but that’s not the biggest issue. Meta is pouring money into Artificial Intelligence (AI), Virtual Reality (VR), and the design of a completely digital “metaverse.” For the moment, those projects are costing a fortune, and they are not bringing in any revenue to offset expenses.

If the metaverse takes off as Zuckerberg expects, Meta will lead the industry, and investors will be rewarded. If it doesn’t – or if it takes too much time to materialize – Meta must continue to rely on advertising revenue. Given current results, that’s a risky bet – one that many investors aren’t willing to take.

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