With such a significant increase, should Meta be sold?

After a 59% surge in stock price this year, how much room for imagination can Meta's robust advertising revenue offer to investors?

Meta's stock price has risen by about 550% since its low point in 2022, up 59% year-to-date, and 86% in the past 12 months, outperforming the S&P 500 index during the same period. This increase is attributed to Meta's enhanced profitability, with Meta having raised its revenue and profit expectations multiple times. Additionally, the market is betting on Meta's potential to become a big winner in the AI field.

However, Meta's current P/E ratio is about 5 times higher than its historical average, and its premium relative to Google has reached an all-time high. Whether to take profits and cash out is a question that investors urgently need to answer.

On October 24, 2024, Eastern Time, analyst Mark Shmulik and his team at Bernstein stated in a report that despite short-term risks of a pullback for Meta, the shortened holiday shopping season in the U.S. this year may pose challenges, but the long-term growth potential for Meta remains strong. The analyst presented six reasons why Meta's core business is expected to continue growing, giving Meta an "outperform" rating and raising the target price from $600 to $675. This implies a 20% upside from the closing price of $563.69 on October 23.

The six core reasons include the advertising growth potential of short video Reels and Threads applications, AI advertising tools that increase ad prices and ROI, as well as AI recommendation algorithms and content creation that keep users engaged for longer.

Caution Needed in the Short Term

Bernstein pointed out that Meta's stock price may face some volatility in the short term.

The report mentioned that on one hand, companies like Temu and Shein had lower-than-expected advertising spending, with a 22% year-on-year decline in ad revenue in the Asia-Pacific region, which could drag down Meta. On the other hand, the growth in political advertising spending in the U.S. was lower than expected, and the shortened holiday shopping season in the U.S. this year, lasting only 27 days compared to the usual 32 days, could impact Meta's ad revenue.

Moreover, Meta's guidance for key metrics in 2025 is limited, and at the same time, if Google performs better, it may attract some investors at lower prices, adding uncertainty to Meta's short-term prospects:

For example, the impact of the shortened holiday shopping season on Meta cannot be ignored. Typically, ad spending peaks during the holiday shopping season, which starts from Black Friday and lasts until Christmas. This year's shopping season is only 27 days, reduced from 32 days last year.

Bullish on Long-Term Growth

However, looking ahead in the long term, Meta's growth potential remains strong. Bernstein expects Meta's core business to continue growing, with the introduction of new ads on Threads, continued growth in short video Reels business, and ongoing advancements in AI and Advantage+ advertising tools at Meta, which could help attract more advertisers and drive revenue growth for the companyHere are six reasons why Bernstein is optimistic about Meta's core business:

1. There is still a lot of room for growth in short video Reels. Reels has already increased user time spent on Instagram by 40% and achieved net income balance in 2023. According to Tinuiti's data, by the second quarter of 2024, the cost per thousand impressions (CPM) of Reels is still about 40% lower than Newsfeed. As advertisers and users become more accustomed to this short video ad format, Reels still has a 15-20% room for price increase. If this happens, by 2025, Reels could bring in approximately $3 billion in additional revenue for Meta.

1. Meta may start advertising on Threads. A year after its launch, Threads has already exceeded 200 million monthly active users and has consistently ranked high in the app store download charts. What's even more exciting is that the ratio of daily active users to monthly active users (a better measure of user engagement) continues to increase, now reaching about 25%, compared to only 14% in August last year. The time users spend on Threads every day is also steadily increasing, from 2.7 minutes last year to 6.6 minutes.

Although Meta previously stated that they do not plan to advertise on Threads until the user base reaches over 1 billion, recently they have started testing promoted posts, which may accelerate the advertising plan. Assuming ads will start running in early 2025, this could bring in approximately $1 billion in additional revenue for Meta by 2025.

1. Advertising spending in the Asia-Pacific region is gradually recovering. Previously, concerns in the market about slowing ad revenue growth in the Asia-Pacific region could drag down Meta's ad revenue, as companies like Temu and Shein saw a 22% year-on-year decline in ad spending in the third quarter. However, Meta optimistically expects revenue to grow by 22% in the third quarter, with no significant decline from Q2 revenue guidance. This may be because there are over 10 million active advertisers on the Meta platform, so even if ad spending from a region or a few major advertisers decreases, the overall impact on Meta won't be significant, as there will always be other advertisers willing to increase their investment to fill the gap.

Moreover, overall market demand for advertising remains strong, especially in the retail and consumer goods industries, with strong growth in ad spending in the travel, financial services, and technology sectors. Therefore, the impact of reduced spending by some advertisers is not significant.

1. AI advertising tools increase ad prices and return on investment. Meta uses artificial intelligence tools to help create and optimize ads, which have already created many ads and increased the conversion rate of ads. Despite rising ad prices, advertisers still find their investment worthwhile because they see improvements in ad effectivenessSpecifically, General Artificial Intelligence (Gen AI) ad creatives have produced 15 million ads with a higher conversion rate than regular ads; new features like Advantage+, such as incremental optimization, have increased the conversion rate by over 20%; Meta has integrated its ad system with third-party analytics tools and CRM systems, resulting in a measurable conversion rate increase of over 30% so far.

In 2023, Meta's revenue growth relies on an increase in ad impressions, although ad prices are actually decreasing. By 2024, Meta's revenue growth becomes more balanced, with second-quarter revenue growth coming from both an increase in ad impressions and rising ad prices.

However, based on the trend from this year to date, the growth in ad prices in the second half of the year may surpass the growth in ad impressions, becoming the main driver of total revenue. Historically, this is often seen as a "lower quality" growth method, but Meta has helped advertisers achieve higher return on ad spend (ROAS) in the context of rising prices, creating a win-win situation for both advertisers and Meta.

Users are spending more time on Meta's various applications. Meta has invested heavily in improving algorithms on their apps, and in the second-quarter financial report, Meta mentioned the decision to allocate more computing resources to training General Artificial Intelligence (Gen AI) models. With more data centers coming online next year, they can use more AI algorithms to help recommend content, leading users to spend more time on their apps.

Meta stated that content recommendation algorithms have increased video watch time by 25% year-on-year, or overall watch time by 10-15%. Bernstein predicts that time spent on Meta's apps will moderately increase by 2025, with growth rates in the mid to high single digits.

Moreover, if Meta's AI can produce more AI-enhanced or synthesized content, users' time spent on these apps may further increase. Meta has tested and hinted that AI-enhanced content can increase user engagement.

Instant messaging services are taking shape. Bernstein observes that, especially in developing countries, commercial instant messaging is becoming increasingly popular. Even without using AI assistants, Meta has significant room to increase revenue by increasing communication volume and raising communication service prices. In addition, the click-to-message ad format is becoming more popular. Bernstein predicts that by 2025, instant messaging services could bring an additional $500 million to $1 billion in revenue to Meta.

Furthermore, if Meta changes the depreciation period of servers, it could save approximately $2.5 billion in costs. Bernstein believes that the market is overly concerned about Meta's capital expenditures, and they trust that Meta can achieve a decent return on invested capital (ROIC) on a reasonable capital expenditure basis while also investing in the next promising projectIn addition, in terms of foreign exchange, as the Fed's rate cut cycle has arrived, the weakening trend of the US dollar may benefit Meta's international business, with overseas income reducing the negative impact of exchange rate fluctuations on Meta's overall revenue.

Therefore, Bernstein expects Meta's revenue to increase by 16% year-on-year in 2025, higher than the market's expected 14% and the overall growth of the digital advertising market by 12%.

Furthermore, Bernstein is optimistic about Meta's other growth opportunities, such as AI and wearable devices.

Profit forecast above market expectations

Bernstein's forecasts for Meta's revenue, earnings per share (EPS), and FCF in 2025 and 2026 are all higher than market expectations.

It is expected that Meta's EPS for the fiscal year 2024 will be $21.73, $25.91 for the fiscal year 2025, and $31.3 for the fiscal year 2026. Meta's revenue and operating profit are expected to continue to grow. Bernstein expects Meta's capital expenditures (CAPEX) and operating expenses (OPEX) to continue to grow in 2025, but holds a positive view on Meta's long-term growth potential and return on invested capital (ROIC)