Meta's Spending Looks Alarming, Until You See What's Behind It

Artificial intelligence (AI) has been around in one form or another for over 50 years, but the technology recently took a giant leap forward with the advent of generative AI. These groundbreaking advances sparked an AI gold rush, but companies that were already proficient in AI had a decided advantage and pounced on the opportunity to stake their claim in the resulting windfall.

One such company is Meta Platforms (NASDAQ: META). The company has a long history with AI and has been at the forefront, using this next-generation technology to carve out greater efficiencies and increase its competitive advantage.

The social media giant reported its third-quarter results, which held a few surprises for shareholders that initially sent the stock plunging. However, a look beneath the hood shows that things are chugging along swimmingly, despite the knee-jerk reaction from fair-weather investors.

Image source: Getty Images.

The good, the bad, and the ugly

To be clear, the news wasn't all bad, but it wasn't all good either, and the results require some important context. Revenue rose 26% year over year to $51.2 billion, accelerating from 22% growth in the second quarter and 16% growth in the first. The results were driven higher by the ever-growing audience on its social media platforms, which rose 8% to 3.54 billion. For context, analysts' consensus estimates were calling for revenue of $49.6 billion, so Meta was comfortably ahead of Wall Street's forecast. That's the good news.

The company's operating expenses climbed 32% to $30.7 billion, outpacing the rate of revenue growth. That's the bad. However, while that might be seen as problematic, there are a couple of valid reasons for the increasing operating expenses (more on that in a minute).

Finally, Meta's diluted earnings per share (EPS) plunged 83% to $1.05, which sent some investors running for the exits. That's the ugly. However, there are several bits of information that provide important context for the headline numbers.

The underlying trends

While the rapid decline in Meta's profitability might be troubling at first glance, there are two contributing factors that are important for investors to understand.

First, there was an unforeseen tax issue related to recently passed legislation. Meta was required to take a one-time, non-cash charge for income tax of $15.93 billion due to the implementation of the One Big Beautiful Bill Act, President Donald Trump's signature piece of tax legislation. This single line item had a dramatic effect on the company's bottom line. Excluding this one-time charge, Meta's earnings would have increased 20% year over year to $7.25. It's also worth noting that Meta expects to benefit from the tax changes over the long term, despite the short-term hit.

Second was Meta's continuing investment in profiting from AI. During the earnings call, CEO Mark Zuckerberg noted that "employee compensation growth accelerated," primarily due to the hiring of AI-related talent. He also cited the acceleration of infrastructure costs, related to the company's growing data center footprint, which not only supports Meta's social media business but is also critical to the company's AI ambitions.

Again, while these additional expenditures may cause some investor concern, the company is already reaping the benefits of its previous AI investments. Zuckerberg said that the "ranking optimizations we made in Q3 alone drove a 10% increase in time spent on Threads" (one of its social media platforms). He also pointed out that "our AI recommendation systems are delivering higher quality and more relevant content, which led to 5% more time spent on Facebook in Q3 and 10% on Threads."

Seeking to capitalize on this trend, Meta narrowed its outlook for capital expenditures for the year to a range of $70 billion to $72 billion, from its previous estimate of $66 billion to $72 billion.

Some Wall Street analysts are comparing Meta's AI-centric spending spree to its ill-fated foray into the metaverse, which yielded billions in expenses but not much in the way of additional revenue. For example, analysts at Benchmark categorized the spending as "runaway capex."

To be fair, however, that isn't an apples-to-apples comparison. Sure, the company is investing heavily in AI, but that spending is already bearing fruit, as evidenced by the accelerating revenue growth and the increases in operational efficiency and business improvements highlighted above.

Given the massive opportunity represented by AI and Meta's demonstrated ability to capitalize on its AI spending, I believe the stock price decline in the wake of its financial report represents a buying opportunity for long-term investors. Furthermore, Meta is attractively priced compared to its Magnificent Seven peers, selling for just 24 times earnings. Its valuation is a bargain, given the magnitude of the opportunity.

Danny Vena has positions in Meta Platforms. The Motley Fool has positions in and recommends Meta Platforms. The Motley Fool has a disclosure policy.