This “Magnificent Seven” stock isn’t getting any benefit of the doubt.
The past 18 months have been quite a ride for many of the “Magnificent Seven” stocks. And no Mag Seven stock has garnered as many eyeballs as AI chipmaker Nvidia, which has surged over 900% since Oct. 1, 2022, to reach a market cap of $2.7 trillion.
But right now, this other Magnificent Seven stock seems like the best value of the bunch. Moreover, its unheralded AI prospects could catapult it into the $2 trillion club, nearly doubling its current value of $1.1 trillion.
Meta’s big investments draw ire but could pay off big
Meta Platforms (META -0.05%) saw its stock sell off after its first-quarter earnings report. But the sell-off may have been due more to outsized expectations than anything else. After all, the stock had surged 40% for the year, even before the Q1 release.
While revenue and earnings per share beat expectations, investors were apparently unnerved by a big increase in the company’s outlook for capital expenditures. Management now expects $35 billion to $40 billion in capital expenditures this year, up from the previous guidance of $30 billion to $37 billion. Not only that, management also stated in the press release that “we expect capital expenditures will continue to increase next year as we invest aggressively to support our ambitious AI research and product development efforts.”
While near-term-oriented investors might have cringed at Meta going on another spending binge, long-term investors should be cheering. After all, Meta has historically gone through investment cycles, and those investments have usually paid off eventually.
Meta’s AI ambitions benefit its core platforms now and going forward
It should be noted that Meta has already benefited handsomely from artificial intelligence (AI). Its graphics processing unit (GPU) investments since 2022 helped increase engagement, maintaining mid- to high-single-digit user growth — no small feat, given Meta’s massive 3.24 billion global user base.
Furthermore, its AI offerings have increased engagement for new products, like Reels, which has fended off formidable competitor TikTok. AI has also enabled advertising customers to not only create and test ads without having to go through a studio but also more precisely target those ads. Solid 7% user growth and better monetization resulted in an impressive 27% revenue growth last quarter.
Last week, Meta even announced it’s seeing younger people flock back to the Facebook platform. In recent years, younger people have flocked to Meta’s Instagram or competitor TikTok, as the Facebook platform came to be seen as a platform for an older generation.
However, on Friday, Meta stated that the core Facebook platform had seen five quarters of healthy growth in its 18-29 age cohort and that over 40 million 18-29-year-olds now use Facebook in the U.S. and Canada, the highest total in three years. The U.S. and Canada are Meta’s highest-revenue geographies, so to see the younger generation flocking back to the core Facebook app is a big positive and proof point that Facebook’s AI-fueled engagement investments are working.
Image source: Getty Images.
But Meta’s AI ambitions go beyond its platforms
Meta is one of the few tech companies that can afford to invest in building generative AI models, and Meta management is seizing the opportunity with its Llama line of models. Unlike competitors, Llama is differentiated by being open-source, meaning outside developers can contribute to it, perhaps giving Llama a leg up on the competition. Furthermore, Meta can obviously use its troves of user data to support its models, honing Llama in ways competitors might be unable to match.
On a recent conference call with analysts, CEO Mark Zuckerberg noted that Llama’s 8-billion and 70-billion parameter models had achieved “best-in-class” performance for their scale. A newer 400-billion parameter model is on the way, which should go toe-to-toe with OpenAI’s ChatGPT and other major large language models (LLMs).
Zuckerberg also explained how the Llama model and Meta AI services could be monetized in the future, citing business messaging (essentially replacing customer service reps), introducing ads into AI interactions (right up Meta’s alley), or charging directly for access to Meta’s most advanced Llama models and computing power.
While Meta isn’t making much at all from Llama today, Zuckerberg urged investors to think long-term:
We’ve historically seen a lot of volatility in our stock during this phase of our product playbook ‐‐ where we’re investing in scaling a new product but aren’t yet monetizing it. We saw this with Reels, Stories, as News Feed transitioned to mobile and more. And I also expect to see a multi‐year investment cycle before we’ve fully scaled Meta AI, business AIs, and more into the profitable services I expect as well. Historically, investing to build these new scaled experiences in our apps has been a very good long term investment for us and for investors who have stuck with us.
And don’t forget Reality Labs
Of course, Meta doesn’t just have one large profitless investment happening today. It has two. While the AI conversation has sucked a lot of oxygen out of the room, Meta is also still aggressively investing in the Metaverse offerings it began several years ago.
Zuckerberg still believes that Meta’s first-mover status in the Metaverse will reap benefits, though perhaps not until the end of this decade as the technology improves. But today, the company makes very little revenue from the Reality Labs Metaverse segment while losing billions every quarter. Last quarter, Reality Labs lost a whopping $3.85 billion.
How Meta could rocket to $2 trillion
When valuing Meta, I try to look at its current core platform alone, stripping out Metaverse losses. Over the past four quarters, the core Family of Apps generated a whopping $69.3 billion in operating income. Slap on a 20% tax rate, and the core business is currently running at a net earnings run rate of around $55 billion.
And keep in mind, the core business is no slouch when it comes to growth, as earnings before interest and taxes (EBIT) were up a whopping 57% over the past year. While the prior year was a “down” year amid a tough economy, it’s not a stretch to think Meta can grow Family of Apps earnings at a 10%-20% rate over the medium term.
A $2 trillion valuation would be only 36 times the current run rate of the core business. That’s not cheap, but certainly not a crazy valuation for a wide-moat business with those types of growth prospects. In fact, that’s the valuation of Mag Seven peer Microsoft, which grew revenue by 17% last quarter and currently trades at 36 times earnings.
So, really, the current core business could theoretically be valued at $2 trillion by itself. And if one assumes Reality Labs has some future business that gives it a breakeven net present value, which is conservative and would essentially amount to a failure, that leaves the Meta AI services that aren’t monetized yet.
Given the tremendous potential for AI services and the promising development of Llama, it’s pretty easy to see how future Meta AI services could become a huge business valued in the hundreds of billions. That alone could catapult Meta’s valuation well beyond $2 trillion, making Meta look like the best bet of the Mag Seven today.