Meta Looks Strong Now, But Long-Term Growth May Hit a Ceiling

Meta Platforms Inc. (NASDAQ:META) is undeniably a very prominent company today. It has already built enormous moats and, quarter by quarter, manages to prove that there is still a lot of shareholder value to be generated, both through increased revenue with maturing initiatives and increased efficiency.

As a result, the prospects for the company are very positive and even reliable, which, with a reasonable valuation, initially makes Meta seem like a good alternative for compounding. However, even in this positive scenario, it is necessary to explore the relevant risks of the thesis, which, in my view, are mainly related to growth expectations that have a natural limit.

Addressing The Bullish Points

Warning! GuruFocus has detected 6 Warning Sign with META.

When we look at Meta's revenue, almost 99% is related to the family of apps, and this revenue is almost entirely composed of advertising. This is one of the risks that will be addressed in the next section, but it is also a positive thing, as the company is an expert in ads.

The breakdown of advertising revenue is the same as the formation of various other types of revenue, basically, the volume of ads and the price of ads. Although the volume of ads is also one of the points of uncertainty in the thesis in the very long term, it is possible to be bullish in the short term.

For a few quarters now, the ad impressions KPI has been growing in the mid single digits, due to an increase in users, but also to the greater number of ads on Meta's platforms. The main argument supporting the idea that this indicator will continue to advance in the coming quarters is that there is still a lot of monetizable space in the company.Meta Looks Strong Now, But Long-Term Growth May Hit a Ceiling

Meta Presentation

Meta knows how to reinvent itself, and it is still possible that it will create new ways to monetize the company, including in apps that are not monetized or are under-monetized, such as Threads and WhatsApp.

But that's not the only thing that should keep revenue momentum going. The main thing, actually, is the price of ads. With AI, the company is becoming increasingly efficient in advertising, which is good for all stakeholders. It is good for advertisers because ads are more efficient, it is good for users because they are receiving more relevant ads, and it is good for Meta because it is able to charge more money for the same space.

As mentioned in the Q1 earnings call, the company continued to advance in AI-driven advertising, and the new models are bringing better conversion rates. The result was a 10% YoY price increase.

Well, we have already established that revenue has very strong prospects for the coming quarters, and that's not even counting some optionalities such as the advancement of forms of monetization for WhatsApp that are not through ads, smart glasses such as those made in partnership with Ray-Ban, and other opportunities. Yet, margin expansion remains a trigger for shareholder value.

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In this regard, Meta continues to show that it is capable of moving forward. Even though it is already very consolidated and has billions in revenue, it still shows that there is operational efficiency to be captured. In Q1 2024, SG&A represented 9% of revenue, and in the most recent quarter, this fell to 5%, with the company continuing to capture scale, advancing in automation and the like. Although R&D remains at high levels to support all initiatives, the trend toward increasing automation is strong and very reliable.Meta Looks Strong Now, But Long-Term Growth May Hit a Ceiling

Meta Presentation

In other words, net income should continue to grow at a rapid pace in the coming quarters and quite possibly in the coming years, and this pace (which should be close to double digits) would justify a slightly higher valuation even without positive surprises.

Addressing Meta's Main Risks

The problem is that there are significant uncertainties in the long term, and the valuation has recently begun to reward the good performance of the last few quarters. Meta is a company with very broad ownership, with several passive and active funds and ETFs with significant exposure.

This is reflected by its high institutional ownership of 68%, and being a core holding in several funds and indexes. One of the consequences of the stock having recently become a consensus is its high valuation, since much of its estimated growth is already priced in because everyone is so convinced that it will happen. In addition, Mark Zuckerberg has already sold a few hundred million Meta shares, and already has plans to sell another $166 million in Meta shares, which may also suggest a more cautious tone.

And in fact, when compared to other mag-7s, this premium valuation is not actually that high. When compared to Alphabet Inc. (NASDAQ:GOOGL), which is another company very focused on advertising, the price-to-earnings ratio is indeed higher. But compared to Microsoft (MSFT), Nvidia (NVDA), or Amazon (AMZN), there is still a significant discount.Meta Looks Strong Now, But Long-Term Growth May Hit a Ceiling

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But the problem is that companies like Microsoft and Amazon have a more diversified business model and a more reliable long-term outlook. Over the past five years, Meta's mean price-to-earnings ratio was 25x and is now 27x, and even though this is not a substantial premium, the company has already shown significant growth.

In my view, Meta's revenue growth has a long-term limit. The number of users has a natural limit, and the company has already reached 3.4 billion Daily Active People on its apps.

Adding a more detailed context, this growth in more mature markets like North America is already close to a ceiling. Even in emerging markets, penetration is no longer low; in Brazil, for example, Instagram had 134 million users in 2024, or around 62% of the population. So there's a dependency on these markets becoming even more mature, and it also creates an execution risk.

The main obstacle to high and sustainable growth in the long term is advertising impressions.

The first reason for this is that there is a very high competition for attention today. Even if people don't stop using Instagram or Facebook, TikTok and YouTube can erode the time spent on these other Meta apps, and new apps will continue to emerge, as well as new ways to spend time, such as games, movies, streaming, live streams, and the like. This creates uncertainty as to whether these impressions can continue to increase in a sustainable manner.

Another very relevant point is the monetizable space. Today, there are spaces that are under-monetized, but most are already quite mature. Instagram reels, for example, already have tons of ads. In my view, there is limited space to increase ads in this regard.

This risk of saturation becomes even more evident when we look at high ARPU. In North America, Meta's ARPU is a highlight, above peers like Snapchat and Reddit, which is reasonable given the company's good execution and scale, but this ends up putting a real question mark of how much higher it can go, mainly in its most profitable regions without affecting the user experience and engagement of its platforms too much.

1 ad for every 10 reels may be reasonable, but if 5 out of every 10 are ads, this can be detrimental and end up reducing the time users spend on Instagram. In other words, this maturity means that Meta has to be increasingly creative to find new ways to capture engagement and monetize new spaces, while running the risk of saturating if it continues to increase the number of ads in already mature spaces.

The pressure on free cash flow due to CapEx is also relevant. Even if this proves to be a strategic investment over time, the truth is that today it is a pressure and that there is a significant level of uncertainty. Investments in the Metaverse, Reality Labs (which still shows a loss), and the like may never materialize and never have a high ROIC, i.e., they are only optionalities but have a cost of capital.

My intention here is not to say that Meta's growth is over. In fact, I believe that the company will be able to continue increasing its revenue and margin for a while, but that this growth will slow down at some point, and this needs to be priced into the stock, as well as its uncertainties.

The Bottom Line

Meta is a good company with excellent prospects for the near/medium term, at least. For an investor who wants exposure to a company that has a lot of value to be unlocked through AI, new technology development, efficiency gains, and heavy exposure to advertising, Meta should be on the radar. With its moats, it should be able to achieve good compounding in its financials over the years.

The problem is that the current valuation does not exactly match the uncertainties that exist in the long term, and this should be considered when investing. Because of this, I do not believe that Meta is currently the best alternative in the tech environment.

This article first appeared on GuruFocus.

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