Key Points
Meta Platforms is bouncing back as the company expands its portfolio of AI products.
These could help the company tap into a significant AI opportunity and complement its strong advertising business.
Meta can also navigate one of its most significant risks.
After lagging the market over the past year, Meta Platforms (NASDAQ:META) is finally bouncing back. During September -- a month that has historically not been great for equity markets -- Meta gained about 25%, while the S&P 500 climbed by less than 1%. Meta has given back some of these gains in October, but for investors focused on the long game, there could be plenty of upside left for the tech leader. Here is why.
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Meta's heavy investments are paying off
Over the past year, Meta Platforms has gone all in on artificial intelligence (AI). The company's significant investments in this field have been somewhat reminiscent of the period when it poured substantial sums into its metaverse ambitions. There is only one problem. Meta Platforms' metaverse efforts did not quite yield the results management expected.
So, it's not surprising that the market was somewhat skeptical of Meta's new focus, which is harming the bottom line. In the second quarter, Meta Platforms' revenue grew by 28% year over year to $60.8 billion. So far so good. However, the company's income from operations dropped 8% year over year to $18.8 billion, with the operating margin at 31%, down from 43% in the year-ago period.
Meta Platforms' net income dropped 14% year over year to $15.8 billion, and the company's free cash flow declined 91% to $784 million. Meta's AI investments were partly responsible for the declining profits. The question for investors is whether the company's spending will pay off and justify its investments.
Recent developments suggest that Meta's spending wasn't in vain. Last month, the company launched Muse, an AI agent that quickly became popular and rose to the top of the list of the most downloaded free iOS apps. Muse can help its users perform a host of tasks and is proactive -- it can act autonomously without a prompt, unlike AI chatbots. The service is free up to certain usage limits. There is a paid tier for those who want more capabilities.
Meta also suggested that it would monetize Muse by charging retailers a transaction fee when the AI agent helps users make purchases. But Meta didn't stop there. The company launched Muse for small businesses. More recently, the company launched Muse Wonder and Muse Wonder Full, two advanced AI models that are on par with the leaders in the field, according to some rankings.
They could allow Meta to compete with OpenAI and Anthropic, two private corporations and among the leaders in AI. Meanwhile, Meta's core ad business remains strong. AI has helped the company improve on this front thanks to algorithms on its websites and apps that keep people glued to their screens, as well as automation tools for advertisers.
Between Meta's strong ad business and the significant new monetization opportunities available through the company thanks to its strong work in AI, revenue and earnings could improve significantly over the medium term, especially if AI spending continues to grow at a good clip.
Navigating legal challenges
Meta's business may improve, but can the company overcome the legal challenges it faces? Meta has been sued for harm caused by its social media platforms, especially to younger users. The company has successfully settled some of those lawsuits. In August, it announced an agreement with a bipartisan coalition of attorneys general representing dozens of U.S. states and territories that were suing the company.
Meta will pay roughly $12.7 billion to these states over a 10-year period, with an extra $5.3 billion contingent on certain conditions. Meta also agreed to set stricter limits and guardrails for younger users across its websites and apps. The amount Meta will pay isn't at all catastrophic, especially considering it will do so over a long period. So, this was a fairly favorable settlement for the company.
The tech leader is dealing with other lawsuits, but my view is that it is well equipped to overcome them. It's also worth noting that Meta is trading at 22.1x forward earnings, versus an average of 19.1x for information technology stocks. Some might argue that the stock is overvalued, especially given its legal challenges. But Meta's AI-related work opens up significant opportunities which, in my view, justify a hefty premium. So, there could be plenty of upside left for investors willing to be patient.
Prosper Junior Bakiny has positions in Meta Platforms. The Motley Fool has positions in and recommends Meta Platforms. The Motley Fool has a disclosure policy.