Investor Essentials Daily

The social media company shows signs of recovery after big losses

February 21, 2023

Last year did not make Meta (META) shareholders happy.

After changing the name from Facebook to Meta and focusing on metaverse investments, Mark Zuckerberg’s company took a big hit in profitability, and naturally to its stock.

Our Embedded Expectations Analysis (“EEA”) shows that the market is still pricing this company’s profitability to go down.

However, as seen from its last earnings call, Meta finally seems to be prioritizing cost-cutting initiatives. If it can replicate what Alphabet (GOOGL) did in the mid-2010s, it might be set up for success.

That’s why Meta Platforms showed up on our FA Alpha Screen. The market’s pessimism and Meta’s growth potential make it a great candidate for FA Alpha 50.

Investor Essentials Daily:
Tuesday FA Alpha 50
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2022 was not a good year for Meta (META).

This poor performance started with Mark Zuckerberg’s statements about the company’s investments in the next big thing – the metaverse.

In October 2021, the company changed its name from Facebook to Meta to show the new grand vision. It has been going downhill since.

The earnings per share (“EPS”) fell short of expectations by a huge margin in the last three quarters. In quarter 4, it was $1.76 instead of the expected $2.23.

The stock has fallen from $379 in September 2021 to $91 in November 2022, a massive 76% drop. Shareholders had never seen the stock price that low since 2015.

It managed to recover a bit to $173 this year, with a 39% increase year-to-date.

Compared to the 13% increase in the overall technology sector, that is an impressive surge. However, that did not happen by chance.

Meta appears to be finally getting religious about costs, as seen from its earnings call late this month.

This seems similar to what Alphabet (GOOGL) did in the mid-2010s, which helped stabilize its profitability and buck market pessimism about its business.

Meta needs to do the exact same thing. The market has been pessimistic about it for too long, and they saw profitability going down.

The return on assets (“ROA”) was stable at around 56% between 2016 and 2019 before crashing to 29% in 2022.

However, falling profitability does not necessarily mean that Meta is a bad investment at the moment.

Making investment decisions should be based on disagreements with the market. If the investor has a different opinion than the overall market, opportunities may be found.

By utilizing our Embedded Expectations Analysis (“EEA”) framework, we can see what is expected from Meta with its $483 billion market capitalization.

Our EEA starts by looking at the company’s current stock price. From there, we can calculate how the market thinks the company will perform in future years. Then, we can see if those expectations make sense or not.

With a valuation of around $173 per share, the market is expecting Meta’s profitability to continue to tank to 12% going forward.

The company’s overinvestment and slowing growth cause the market to undervalue it by a large margin.

However, considering that Meta has started to embark on cutting costs and rationalizing the business, this valuation seems overly pessimistic.

When the company is operating at full speed, it is a high-return business and still has growth opportunities.

It is true that it has a lot of work to do to right the ship, but the extremely pessimistic valuation and the growth potential mean that Meta is a great FA Alpha 50 name.

Throughout financial market history, many of the world’s most successful investors have been candid in their belief that Generally Accepted Accounting Principles (“GAAP”) distort economic reality.

Warren Buffett, for example, once said investors should “concentrate on the world of companies, not arcane accounting mathematics.”

Investors who neglect the very real issues with as-reported accounting can find themselves caught up in investing with the crowd, blindly following hot “themes” without a thorough grasp of how to understand the businesses in question.

The only true way to focus on the “world of companies,” as Buffett suggests investors do, is to present a clear picture of how a business operates, something that can only be done by adjusting financial statements to reflect the arbitrary nature of certain accounting rules that leave much to discretion.

The world’s best investors understand the need to make these adjustments, which allows them to focus not on picking out the most popular companies but rather on looking for great names in sleepy areas that the market isn’t paying much attention to. From there, the goal is to then identify quality companies with significant growth potential at reasonable prices.

That’s exactly what we’ve set out to do with the FA Alpha, our monthly list of 50 companies that rank at the top for quality, high growth, and low valuations.

This list has outperformed the market by 300 basis points per year for over 20 years now, effectively doubling the performance of the market by focusing on the real fundamentals and valuations of companies with our proprietary Uniform Accounting framework.

See for yourself below.

To see the other 49 names on the list, click here.

Best regards,

Joel Litman & Rob Spivey

Chief Investment Strategist &
Director of Research
at Valens Research

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