Meta Earnings: AI Investments Are Paying Off, Reels Monetization Improving

Meta Stock at a Glance

• Fair Value Estimate: $311
• Morningstar Rating: 3 stars
• Morningstar Uncertainty Rating: High
• Morningstar Economic Moat Rating: Wide

Meta Earnings Update

META again displayed its strong network effect moat source as its user base across all apps increased, engagement remained healthy, and monetization improved further during the second quarter. Advertisers are gaining confidence in Meta’s enhanced and artificial intelligence-powered campaign planning and measurement capabilities, and spending more.

Unsurprisingly, Reels monetization keeps improving. We also applaud the firm’s continuing focus on cost control and overall efficiency, which resulted in year-over-year margin expansion for the first time since second-quarter 2021. We think margin expansion likely will continue through 2027, albeit with continuing losses at its Reality Labs.

Raising Fair Value Estimate on Meta Stock

We have increased our fair value estimate of wide-moat Meta to $311, from $278. With the stock more than tripling its 52-week lows, we now believe it is now fairly valued, with much faster revenue growth than initially anticipated this year and higher long-term margins now priced into the shares.

Total revenue of $32 billion is up 11% from last year and 12% on a constant-currency basis. Meta’s user count increased in all regions. Engagement across Meta’s family of apps increased as average monthly and average daily users jumped 6.3% and 6.6% from last year, respectively. The Facebook app also experienced higher engagement, with growth in both monthly (up 3.3%) and daily (up 4.9%) users. Advertising revenue grew 12% from last year to $31.5 billion as more impressions were sold (up 34%), more than offsetting Reels-driven lower prices (down 16%).

AI Investments Showing Immediate Returns

The increase in engagement displays immediate returns on Meta’s AI investments, as content recommendations from nonfollowers and overall easier content search are keeping users on the platforms longer.

Operating margin improved 35 basis points to 29.4%. Excluding restructuring charges, operating margin was 31.8%. We expect significant operating leverage from accelerated revenue growth because of the firm’s success in streamlining its operations.

We commend Meta’s AI investments, which are mainly focused on increasing user engagement, easing ad placement, and improving ad returns on investment, all at lower costs for the firm. Meta’s content discovery and recommendation enhancements have led to more than 200 billion Reels played per day, which has tripled Reels’ annual revenue run rate to around $10 billion from last year, according to management. In addition, Meta has begun to apply its large language model LLaMA internally to its platforms where it can help users create more content. Plus, the firm’s Advantage+ AI-based product is now helping advertisers better automate the creation, placement, and targeting of ads.

Regarding Threads, while we are pleased with the early user count of the app, uncertainties regarding user retention in the long run and monetization remain. According to estimated data from Quiver Quantitative, more than two weeks after the apps’ user count hit 100 million (in only four days), it has added only around 18 million users. As mentioned in our July 11 note, we still think that if monetized successfully, revenue from Threads would add only another 3%-6% to our fair value estimate of Meta.

We have also increased our margin assumptions as we think Meta’s AI investments may strengthen the firm’s network effect and reduce needed sales and marketing spending to retain users and attract advertisers. Regarding the advertising side, AI-powered tools like Advantage+ should not only attract more ad spending but would also increase efficiency for Meta’s ad placement capabilities. We now expect operating margin to improve to 37% by 2027, from our projection of 31% this year.