🤳📱 Business Overview

🎯Key Metrics

Total: 12.5/17

• +2 ✅✅ Projected Operating Margin: 35.00%

• +2 ✅✅ Projected 5-Year Revenue CAGR: 20.00%

• +2 ✅✅ Last 5-Year ROIC: 20.56%

• +1 ✅ Estimated Cost of Capital: 9.92% (lower than ROIC)

• +1 ✅ Last 5-Year Shares Outstanding CAGR: -2.35%

• +2 ✅✅ Projected 5-Year EPS CAGR: 20.08%

• +1 ✅ Projected 5-Year Dividend CAGR: 11.97%

• +1.5 ✅ Estimated Debt Rating: Aa3

• +2 ✅✅ Morningstar Moat: Wide

• -1 ❌ Morningstar Uncertainty: High

Meta is probably one of the most known and controversial technological companies there is. Zuckerberg for better or for the worst revolutionized how we see ourselves and those around us, how we communicate and interact with each other. It spearheaded most of the communication technology we use and come to expect today.

The company, despite all the controversy and regulation around and expected in the future, still has stellar metrics, shown above.

I forecast that in the future Meta will still be able to grow its revenues at above average rates, maybe even expanding to some other business segments. However, I expect some regulatory pressure over its Family of Apps business that will contract its overall margins.

Please note all of these are just my assumptions, taking everything I know about the company, its current state and my expectations over the business, the economy and overall world. Each of these, I will try my best to explain and detail over the next sections.

A little disclaimer before we begin, I normally use the key metrics above to help me allocate capital over my investment portfolio, however take everything on this valuation post with a grain of salt. I will guide you through all my thought processes but will also provide you with all the tools to override/change everything about it, so you can come up with your own value for the company. As with anything, take responsability for your own investment decisions.

📈Business Valuation

Before presenting you with a final and raw number, I will show you first my own assumptions, as well as the data that led to that. My final objective here is to write down my valuation thoughts (ramblings?) and hopefully, in the process, learn and help you learn something new.

Revenue Growth

Below is the last ~10 years of revenue growth for Meta:

💡I expect the next year revenues to be around ~20-30% (Year 1) and then float around ~15-25% (Years 2-5) over the next couple of years, following the historical trend of the company, but expecting values a little below its median of ~27%.

Cost of Capital

I’ve used the latest quarterly and annual report of the company, the 10-Year US bonds as the risk free rate and revenue geographic exposure to come up with its cost of capital, cost of debt and cost of equity. Also, given the fact that Moody’s provided a rating for the company I used it as the debt rating.

Cost of Capital: 9.92%

This value will be used later as a discount rate in the valuation methods.

Please feel free to come up with your own values by using the tool I’ve used: Cost of Capital – The Fair Value Journal. It is and will ever be completely free 🙂

Also, keep in mind that the average cost of capital in the US for a company similar to Meta in the Software (Entertainment) industry is ~8.44%.

💡My assumption for the cost of capital is that it would remain at the current values ~9.92% given the riskiness that comes with the uncertainty of the company. However later on, we explore using the Monte Carlo simulations scenarios where the company converges into a more traditional company within its industry becoming a lower cost of capital company.

Operating Margin

Meta spreads its revenues over 2 business segments, described below:

Family of Apps: 99.01%

• Facebook, Instagram, Messenger, WhatsApp, etc.

• operating margin: 46.92%

The Family of Apps segment has maintained its operating margin. I expect this value to contract over the next couple of years given the overall regulatory pressure, now very strong in Europe, projected to increase and spread across the whole world.

Reality Labs: 0.99%

• Virtual and Augmented Reality related consumer hardware, software and content

• operating margin: -845.93%

The Reality Labs segment is where Meta comes up with new business opportunities. For now its clearly a cash-burner of a segment that, despite being meaningless in the grand scheme of things, accounting only for ~1% of revenues, it still depreciate the company overall margins. However, I expect that from this segment may appear over the next couple of years new business segments that may push forward the company overall growth.

The graph below shows the overall operating margin for Meta:

💡I expect this margin to begin at around ~36-40% and gradually converge to ~30-45% to allow for some uncertainty over the regulatory pressure and social media fatigue (lower end) and expansion into business segments with higher profitability (higher end).

Now, we can also map out and see the graph for the contribution of each segment to the company revenues over time:

As you can see, the Reality Labs segment is clearly overshadowed (and well) by the Family of Apps business segment. I expect this to be maintained over the next couple of years at least.

Sales / Capital ratio (Reinvestment)

This ratio shows you how the capital invested is being translated into the business revenues. Please remember that sometimes the company may invest today to only reap the benefits and sales after a couple of years.

Below you can see the last ~10 years of Sales to Capital ratio for Meta:

Its clear to see that the company has been investing for the future. We can see this by the contraction of this ratio of ~1.1-1.3 into the current 0.8-1.0 over the last 5 years.

💡My assumption is that the company will begin next year at around the same values, even decreasing a little bit into the ~0.75-0.85 range and gradually converge into ~0.6-1.2 range (focus on the lower end) to allow for some uncertainty on its AI reinvestment needs (lower range) and the payoff for its current reinvestments (higher range).

ROIC

Still related with the company’s reivestments, but this time with their return on the capital invested.

This ratio has also seen a slight contraction over the last 5 years:

However, it still is very good and still above (well above) the estimated cost of capital.

💡My assumption is that the company will still be able to return above its cost of capital long-term. I will have it converge to a ROIC within the range of ~8.44% (industry cost of capital) and a maximum of ~15% with a higher focus over the higher end, because I believe that this company will still maintain some competitive advantages long-term.

Discounted Cash Flows (Weight: 60%)

I’ve used the latest annual report and my assumptions explained above to complete my Discounted Cash Flow valuation:

Some notes on the inputs above:

• Terminal Revenue Growth – I’m using the risk-free rate (10-Yr bonds of the US), because long term the company should not grow more than the rate of the economy. I’m using the risk-free rate as a proxy to it, so the terminal growth becomes it;

• Initial and Terminal Tax Rate – Given the fact that its recent averages are around ~22% I’m assuming the same value for both.

All the other inputs were taken from the financial statement or from my assumptions.

The DCF gives us an estimated fair value of $668.69 dollars for Meta.

Something that we can also do now is to play around with Monte Carlo simulations. What this will allow us to do is to simulate multiple DCF valuations with pre-defined ranges for each of the inputs. Each simulation will randomize the inputs between these pre-defined values. For this I also used my assumptions and the range explained on during those sections.

As you can see from the above Meta seems to be undervalued given that its current price of $578 is below P10. From these simulations we can extrapolate that there’s more than ~90% probability of Meta being undervalued.

Please be free, as before, to fill in your own values. Make the valuation your own and do yourself a DCF valuation using your own assumptions: DCF – The Fair Value Journal

EPS Growth (Weight: 40%)

For the EPS valuation, I designed three different scenarios, to be used later on the Monte Carlo simulation: a bad, a base and a good scenario. Everything about them is explained below.

Please note that the Trailing Twelve Months (TTM) EPS for the company is $26.90.

Also some relevant historical notes about the company:

Revenue Growth (CAGR)

💡 This was discussed earlier, but it is expected for the company to grow its revenues between ~15-25% (CAGR) over the next 5 years.

Shares Outstanding (CAGR)

💡 I expect this to be maintained within -0.20% and -1.40% over the next 5 years.

Net Profit Margin (Average)

💡 As we discussed previously during the operating margin section, I expect this margin to contract a little bit from its historical norm into the ~27-32% range.

P/E ratio (Average)

💡 I expect this to also remain around be maintained or even contract a little bit from its historical values into ~20-26.

Knowing this, these were my three scenarios for the next 5 years:

Bad Scenario

• Revenue Growth (CAGR): 15.00%

• Net Profit Margin (Average): 27.00%

• Shares Outstanding (CAGR): -0.20%

• P/E ratio: 20

• EPS 5th Year: $49.04

• EPS CAGR: 11.15%

Base Scenario

• Revenue Growth (CAGR): 20.00%

• Net Profit Margin (Average): 29.00%

• Shares Outstanding (CAGR): -0.80%

• P/E ratio: 23

• EPS 5th Year: $67.16

• EPS CAGR: 21.73%

Good Scenario

• Revenue Growth (CAGR): 25.00%

• Net Profit Margin (Average): 32.00%

• Shares Outstanding (CAGR): -1.40%

• P/E ratio: 26

• EPS 5th Year: $93.70

• EPS CAGR: 33.34%

Given these assumptions and based on the historical data, I filled in and valued the company using the EPS Growth projections, discounted by the estimated cost of capital previously calculated and using the assumptions of the base scenario.

Then again, I used the Monte Carlo simulations to explore the possibilities on the lower (bad scenario) and on the higher (good scenario) end.

From this valuation, Meta looks undervalued given that its current price of $578 is below P10. We can extrapolate that there’s more than ~90% probability of the company being undervalued.

As before, feel free to try this yourself: EPS Growth – The Fair Value Journal

EPS Scenario Returns

We can also explore a little further the different scenarios by projecting in time the bad, the base and the good case scenarios.

Feel free to try this yourself: EPS Scenario Returns — The Fair Value Journal

✍️Summary

Now that we did all the heavy work, let’s take all of the above and come up with the company weighted average fair value.

I basically take each valuation method used and given my confidence on the company apply a 20% or 10% discount (when to buy) and addition (when to sell) or use the Monte Carlo P10, P20, P80 and P90 values.

Remember, a lower fair value represents the likelihood of a worst-case scenario playing out, while a higher fair value reflects the potential of a best-case scenario unfolding.

Feel free to choose your own values, but for me I would start adding again or initiating a position in Meta below $740.31, because despite not being a fan of social media and the overall business in itself, I’m a great believer in the cash machine that Zuckerberg transformed Meta into and the potential that this company have to reinvent itself in the future.

Please, as always, remember that the fair value estimate has a 100% probability of being wrong and it will never be a precise number, even if it has decimals next to it 😮

As a long-term investor in the company I see the current decline in price as a welcome and long-awaited opportunity to increase my position in the company because, Meta appears to be undervalued at its current market price.

Fair Value: 842.67 dollars.