Increasing fair value for meta stock on AI and ads…

• Estimated fair value: $560
• Morningstar rating: 3 stars
• Economic evaluation of the trench: wide
• Uncertainty rating: high

While the company’s AI investments could improve its core business, we remain pessimistic about the long-term value created by Meta’s investments in the Reality Labs division and downgrade our Morningstar Equity Rating to Standard from Exemplar.

We consider Meta the clear leader in social media. The company’s suite of apps, which includes Facebook, Instagram, WhatsApp and Messenger, has nearly 4 billion monthly active users, giving Meta unparalleled scale in the space.

The company’s strategy has two directions. On the user side, Meta has leveraged its breadth and experience in social media to improve its product lineup, adding features like Stories, Reels, and even new products like Threads. Such enhancements and additions not only improve user engagement, but also allow Meta to increase revenue by layering ads on them.

The shift to digital advertising

On the advertising side, Meta allows advertisers of all shapes and sizes to place ads in front of engaged users. The company has benefited greatly from a general shift to digital advertising in the wider advertising market, with social media advertising gaining substantial share, especially after the covid-19 pandemic. To strengthen its advertising business, Meta has invested heavily in improving its ad targeting algorithms, enabling it to improve advertisers’ return on ad spend and increase its average revenue per user over time.

We estimate that Meta’s sales will grow at a compound annual growth rate of 12% over the next five years, led primarily by an increase in average revenue per user as users grow as well. We believe Meta has a strong opportunity ahead in Asia and the rest of the world.

While we expect ad sales to grow steadily in North America and Europe, we believe the increasingly affluent and growing middle classes in Asia, Africa and the Middle East will provide Meta with an opportunity to improve its monetization ads in those regions.

While we expect Reality Labs’ sales to grow at a double-digit rate over the next five years, we believe Meta’s advertising machine will remain the primary driver of its business and intrinsic value relative to our explicit forecast.

From a profitability perspective, we remain impressed with Meta’s ability to drive efficiencies in its operating footprint, with the company’s 2024 GAAP operating margins expected to be close to 40%, up from the 2022 low of 25%.

Looking beyond advertising

Looking ahead, we believe the company’s profitability will remain at current levels above our five-year explicit forecasts, as increased efficiency is offset by expanding investments in areas such as AI and Reality Labs.

While the company’s core business remains advertising, Meta has shown a willingness to expand beyond its ad-based revenue model by investing heavily in hardware through Reality Labs and in AI by investing in its own language model great Llama. While the company’s investments in Reality Labs have proven unprofitable, we are more optimistic about Meta’s investments in AI. We view Meta’s AI investments, particularly those aimed at improving the company’s ad targeting algorithms, as adding value.

Beyond ad targeting, Meta is also investing in consumer-facing AI through its Llama chatbot, which is accessible to users through its apps. While a monetization strategy for this chatbot remains elusive in the short term, we believe the firm could increase user engagement/time spent by giving its users access to a chatbot assistant in Meta apps.