Meta Platforms Inc. (META, Financial) boasts a market cap exceeding $1 trillion and is a member of the renowned "Magnificent Seven." Operating primarily in two segments, Family of Apps and Reality Labs, its products—Facebook, Instagram and WhatsApp—are integral to people's daily lives. Founded 20 years ago, the company went public in 2012 and has since grown into a tech powerhouse.

CEO Mark Zuckerberg's vision has propelled Meta to an impressive start this year, maintaining the momentum from last year. Known for its extensive portfolio of social networking apps, the company has been aggressively integrating AI across its platforms to enhance user engagement and monetize its vast user base. Despite a 30% year-to-date rally, Meta Platforms remains relatively undervalued within the Magnificent Seven group. The gains have been fueled by robust quarterly results and strong revenue growth, positioning the company to leverage AI to strengthen its core advertising business further.

The company's substantial investments in generative artificial intelligence has led to successful monetization, significantly boosting advertising revenue and margins. Additionally, Meta's shares have nearly quintupled from their 2022 lows, driven by a relentless focus on efficiency, the success of Reels and best-in-class ad targeting capabilities in a post-app tracking transparency landscape. As Reels monetization reaches neutrality and AI integration continues to receive significant attention and resources from Zuckerberg, investors are once again optimistic about the company's future.

Despite its impressive performance and record-high share price, I believe Meta has significant upside potential. This optimism is grounded in its strong fundamentals and strategic AI integration across its family of apps. Further, I see substantial growth potential for Meta despite its already impressive achievements.

Overcoming ATT challenges

In April 2021, Apple (AAPL, Financial) introduced the app tracking transparency framework with an iOS update, disrupting platforms like Facebook by limiting their ability to track users across apps. This change hindered Meta's ability to measure the return on ad spend with the same precision, as deterministic measurement of ad conversion rates was no longer possible.

Consequently, Meta was forced to pivot to a probabilistic model, necessitating billions of dollars in investment, particularly in GPUs, to develop a machine learning algorithm for estimating ad conversion rates. This substantial investment strengthened Meta's competitive moat, positioning it and Alphabet (GOOG, Financial) (GOOGL, Financial) far ahead of competitors in terms of measurement and targeting capabilities.

These early AI investments not only helped Meta navigate the post-ATT landscape, but also enhanced its self-sufficiency amid broader industry transformations. The company's extensive reach across its diverse Family of Apps—spanning text, image and video formats—continues to benefit from these strategic advancements.

Source: Meta Investor Relations

Customized chip projects and AI integration

Meta is well-positioned to capitalize on tighter integration of its technology stack thanks to its robust ecosystem and strategic partnership with Nvidia (NVDA, Financial). The company's customized chip projects have yielded successful outcomes, such as the launch of MTIA 2. This updated Meta Training and Inference Accelerator is specifically optimized for the company's recommendation algorithms, further strengthening its competitive advantage against smaller digital advertising peers in the generative AI era.

The company's first-quarter earnings commentary highlights the success of its engagement efforts, particularly in Instagram Reels, which now accounts for 50% of the time spent within the app. The significant investments in artificial intelligence have primarily focused on the Family of Apps, enhancing ad efficiency. Higher return on investment for advertisers on platforms like Facebook and Instagram encourages continued ad placements, driving Meta's growth trajectory.

Advancements in AI and new models

Meta's growth is propelled not only by increased AI investments driving total ad impressions, but also by robust AI monetization across its Family of Apps. For instance, Threads has reached over 175 million monthly users and is now focusing on ad monetization. Additionally, the company introduced an updated version of Meta AI powered by the latest model, Llama 3, which enhances user engagement by helping users explore topics of interest more effectively. Recognized as one of the leading AI assistants globally, this model lays the foundation for developing a wide array of new applications. Leveraging its vast social networking data, Meta can generate significant AI returns through various new models, including targeted advertising, which could substantially boost its advertisement revenue.

Consistent top-line growth and impressive earnings

Meta Platforms has demonstrated a solid track record in earnings over the past several years. Despite occasional misses on earnings per share, largely due to challenges in its virtual reality ventures and an advertising slowdown, the company has consistently surpassed analyst estimates for top-line results. Revenue has reaccelerated after a slowdown in 2022, propelling its trailing 12-month results to all-time highs for both revenue and net income.

Source: Meta Investor Relations

In its first-quarter results, which were released on April 24, Meta reported earnings of $4.71 per share, beating analysts' estimates by 39 cents. Revenue for the quarter stood at $36.50 billion, up 27.30% year over year and surpassing estimates by $240 million. This robust performance was driven by several key factors:

• Growth in daily active users, which rose 7% year over year to 3.20 billion in the first quarter, boosting engagement and yielding a 20% increase in ad impressions.
• Increased advertiser spending led to a 6% boost in the average price per ad.
• Significant investments in AI improved ad targeting and measurement tools, driving top-line growth.

Average revenue per person saw an 18% year-over-year increase, highlighting Meta's effectiveness in monetizing its extensive user base and generating more revenue per user. This achievement is particularly noteworthy given the challenging economic backdrop affecting many businesses. Looking ahead, the company is focused on monetizing engagement by leveraging AI-driven features across its Family of Apps, significantly enhancing monetization efficiency.

Improved operating efficiency and margins

Meta's disciplined cost management has been crucial in improving its operating efficiency and profitability. In the first quarter, the company's total costs grew by just 5.70% to $22.60 billion. This prudent cost management expanded the company's net profit margin by 1,400 basis points to 33.90%, enabling diluted earnings per share growth to far outpace revenue growth.

In 2022, the company increased its capital expenditure by 68% to build up AI infrastructure amid the generative AI boom, which impacted its free cash flow, leading to a 50% year-over-year decline. The stock subsequently dropped nearly 73%, from $331 to $91, in less than 11 months. However, a strong ROI from these investments boosted the company's fundamentals, as reflected in the 2023 earnings results. Now, Meta is entering another capex cycle to strengthen its AI research and development.

Source: Meta Investor Relations

Strategic AI investments and future growth

Meta has been heavily investing in artificial intelligence, a trend likely to continue as the company optimizes and implements AI across its platforms. The company now anticipates 2024 capex to be between $35 billion and $40 billion, up from the previous range of $30 billion to $37 billion. Despite the substantial capex, I do not foresee a significant headwind in free cash flow as Meta's recent AI initiatives suggest a keen focus on quickly monetizing its projects.

Based on the company's strong ROI track record, I believe these AI investments will generate substantial returns in 2025. Enhancements in both engagement and ad performance should translate into continued revenue and earnings growth, reinforcing the Meta's position as a leader in the social media and digital advertising landscape.

Significant upside potential

Despite the stock's significant year-to-date performance, Meta currently trades with a forward price-earnings ratio of 18.40 based on projected earnings for 2024. This is notably lower than the Magnificent 7 average of 29.40. The multiple aligns closely with Alphabet's forward earnings ratio of 18.10, both of which are considered undervalued relative to their peers.

It is common for companies of this caliber to trade at 25 to 30 earnings, particularly in an environment where interest rates are expected to decline. Such a decline could prompt investors to rotate out of fixed-rate investments and back into the stock market, potentially boosting Meta's valuation.

Source: Alpha Spread

In comparison, both Alphabet and Meta trade below Apple's forward price-earnings ratio of 28.40 and Microsoft's (MSFT, Financial) forward multiple of 29. Given this context, I believe the stock still has substantial upside potential. Meta currently ranks as the second least expensive stock among the Magnificent Seven based on forward price-earnings, trailing only Alphabet. If the stock returns to the peer average multiple of more than 28 times earnings, it could see a significant price increase. This implies a strong potential to reach a price target of $610 by the end of the year.

Using a discounted cash flow valuation approach, with a 7.75% discount rate reflecting Meta's capital structure and risk profile and assuming a 3% terminal growth rate beyond the initial five years, we can estimate the stock's intrinsic value. This terminal growth rate accounts for Meta's anticipated strength in the near to medium term, driven by emerging opportunities in AI and digital advertising. The DCF model yields a target value of $659.44, indicating an upside potential of approximately 24%.

Both valuation methods—peer comparison and DCF analysis—suggest substantial upside for Meta. I remain confident that the company is well-positioned to capitalize on this potential, underpinned by its leadership in digital advertising and growing AI opportunities. This positions Meta as a compelling buy, offering strong upside prospects in the current market environment.

Conclusion

Meta Platforms has demonstrated impressive growth and resilience, leveraging AI integration and strategic investments to enhance user engagement and advertising revenue. Despite a significant rise in value year to date, the stock remains relatively undervalued compared to its peers in the Magnificent Seven. With strong fundamentals, robust AI-driven growth and prudent cost management, the company is well-positioned for continued expansion and substantial upside potential, making it a compelling buy in the current market environment.