If you bought Meta Platforms (NASDAQ:META) shares earlier this year, chances are you aren’t complaining. META stock is up by over 168% year-to-date, and has nearly tripled from its 52-week low.
But for those who have dived into the Facebook and Instagram parent’s shares more recently, instead of “no complaints,” you may be feeling frustration and concern regarding this leading tech stock.
Since the summer, META has more or less traded sideways, as investors digest various fears, uncertainties, and doubts. Some are laying out bearish arguments about META’s performance in the months/year ahead. However, it’s far from a lock that less stellar returns are just around the corner.
In fact, beyond just from the reporting/anticipation of continued earnings growth, shares could rise for another reason in the medium and long-term. It all has to do with META’s relatively lower valuation compared to many of its peers.
Why META Stock Has Yet to Become Overvalued
In late 2022, Meta Platforms was trading at a price-to-earnings ratio in the low-teens. This put shares well-within value stock territory. You can no longer buy META at such a bargain basement valuation, but while no longer undervalued, this stock isn’t overvalued, either.
One reason is that META stock trades at the lower end of the valuation range compared to the “Magnificent Seven” stocks.
As you may know, the “Magnificent Seven” are the seven tech stocks that play an outsized role in driving the movement of the broad market. Apple (NASDAQ:AAPL), Amazon (NASDAQ:AMZN), Alphabet (NASDAQ:GOOG,NASDAQ:GOOGL), Nvidia (NASDAQ:NVDA), Microsoft (NASDAQ:MSFT), and Tesla (NASDAQ:TSLA) are the other six stocks in this category.
Of this group, TSLA and AMZN are valuation outliers, with forward P/Es of 75.1 and 55.6, respectively. AAPL, NVDA, MSFT trade at forward multiples between 30 and 40. In the case of META? Meta Platforms and Alphabet trade at around 23 to 24 times earnings, significantly lower than their peers.
Admittedly, there are some solid reasons a valuation discrepancy exists. Even so, there’s still a path for this gap to narrow.
A Justified Discount? Maybe Not
It goes without saying why neither META stock nor GOOG stock trades at a multiple on par with TSLA or AMZN. These companies (at least, in the minds of the market) have strong potential to report extremely high levels of earnings growth over the next few years.
When it comes to why META and GOOG trade at discounts to, say AAPL, MSFT, and NVDA, the fact both these companies have advertising-focused revenue models explains much of it. The cyclicality of advertising demand suggests a greater level of earnings cyclicality. With Apple, Microsoft and Nvidia’s revenue models product/subscription-focused, perceived certainty about future results is much higher.
Nevertheless, while a valuation discount is warranted, is the current discount justified? Maybe not, as it may be too wide. Chances are this overly wide gap won’t correct on its own, through some sort of “valuation is its own catalyst” type of scenario. However, the respective AI catalysts for Meta and Google could help to bridge it.
I’ll save a more detailed discussion about how AI could help re-rate to the upside for another article, but below is how exactly Meta’s AI catalyst could lead to a substantial re-rating for its shares.
This One Pivot Could Make All the Difference
Ongoing economic challenges could lead to lower-than-expected digital advertising demand next year. However, Meta’s effective use of AI to increase ad revenue from its existing social networks, plus the launch/monetization of new ad-supported applications like Reels may outweigh any re-softening of demand.
Better yet, beyond just improving Meta’s existing revenue model, the company could also turn its AI breakthroughs into new revenue streams.
Similar to how AAPL has been re-rated thanks to its pivot towards a services-based revenue model, a pivot away from a strictly advertising-based revenue model may enable META to move toward a forward valuation in the high-20s/low-30s range.
Taking this into account, if you’re an existing META stock investor, and have been mulling whether to take profit, give it some more thought. If you’ve been hesitant to buy given fears of a sell-off, let my argument help to assuage your concerns.
On the date of publication, Thomas Niel did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
