Should You Invest In These Social Media Companies?

Since the birth of Facebook in 2004, social media has had an ever-increasing presence in everyday life. Facebook now has almost three billion monthly users. In total, over 4.5 billion people use social media, more than half of all people on Earth. The global social media market was $160 billion in 2021 and is expected to reach $833 billion in 2026, with a compound annual growth rate (CAGR) of 39.7%.

Over the last decade, companies have begun to use the large reach of social media sites as a marketing tool. In fact, over 90% of companies worldwide use social media for marketing. This is how social media companies make the majority of their money. Additionally, some offer a subscription service for added features.

Despite the rapid rise of these companies, earnings have not been positive in 2022. Many companies are missing estimates—and by a large margin. Meta’s second-quarter earnings were released in late July and revealed the company’s first year-over-year decline in revenue since going public in 2012. Net income was 36% lower than a year earlier. The main driver behind the decreases in revenue across social media companies comes as a result of slowing demand for their ad platforms. Meta reported a 14% year-over-year decline in the average price per ad. Companies have attributed the decline in ad performance to troubling economic conditions.

Twitter has struggled to match the performance of competitors. Since its initial public offering (IPO) in 2013, the company’s stock is down. Attracting users has been troublesome for the company, with many citing poor user experience. Due to this, it hasn’t been as desirable for advertisement as YouTube and Facebook.

In April, Tesla CEO Elon Musk offered to buy Twitter for $41.1 billion, a nearly 40% premium to what the company was trading at before the offer was made. Musk said that he hoped to unlock the platform’s potential for free speech globally. Shortly after, Twitter’s board of directors adopted a “poison pill” provision in the hopes of stopping the takeover. This was ultimately ineffective, and Twitter soon agreed to sell itself to Musk.

However, in May Musk put the deal on hold claiming that the number of fake accounts was much higher than Twitter had reported. In early July, Musk moved to terminate the acquisition over alleged failure of Twitter to provide him with the data needed to evaluate the number of spam and fake accounts. Twitter has now set in motion a lawsuit against Elon Musk over a “long list” of violations of the merger agreement.

Overall, the next few years will be crucial for social media companies. Continuing to grow users and ad platforms will be vital to success. Additionally, adapting to an increasingly competitive environment will be essential. Many platforms such as Instagram, YouTube and Snapchat have begun implementing features imitating TikTok after seeing its rapid rise in popularity. However, the troubling economic outlook could prove to be difficult to navigate.

Grading Social Media Stocks With AAII’s A+ Stock Grades

When analyzing a company, it is helpful to have an objective framework that allows you to compare companies in the same way. This is why AAII created the A+ Stock Grades, which evaluate companies across five factors that research and real-world investment results indicate to identify market-beating stocks in the long run: value, growth, momentum, earnings estimate revisions (and surprises) and quality.

Using AAII’s A+ Stock Grades, the following table summarizes the attractiveness of three social media stocks—Meta, Snap and Twitter—based on their fundamentals.

AAII’s A+ Stock Grade Summary for Three Social Media Stocks

What the A+ Stock Grades Reveal

Meta Platforms Inc. (META), formerly Facebook Inc., builds technologies that help people find communities and grow businesses. Its products enable connection and sharing with friends and family through mobile devices, personal computers, virtual reality (VR) headsets, wearables and in-home devices. The company operates through two segments: family of apps (FoA) and reality labs (RL). FoA includes Facebook, Instagram, Messenger, WhatsApp and other services. RL includes augmented and virtual reality consumer hardware, software and content. The Facebook platform enables people to connect, share, discover and communicate with each other on mobile devices and personal computers. Instagram is a place where people can express themselves through photos, videos and private messaging, and connect with and shop from their favorite businesses and creators. Messenger is a messaging application for people to connect with friends, family, groups and businesses.

A higher-quality stock possesses traits associated with upside potential and reduced downside risk. Backtesting of the quality grade shows that stocks with higher grades, on average, outperformed stocks with lower grades over the period from 1998 through 2019.

Meta has a Quality Grade of A with a score of 99. The A+ Quality Grade is the percentile rank of the average of the percentile ranks of return on assets (ROA), return on invested capital (ROIC), gross profit to assets, buyback yield, change in total liabilities to assets, accruals to assets, Z double prime bankruptcy risk (Z) score and F-Score. The score is variable, meaning it can consider all eight measures or, should any of the eight measures not be valid, the valid remaining measures. To be assigned a Quality Score, though, stocks must have a valid (non-null) measure and corresponding ranking for at least four of the eight quality measures.

The company ranks strongly in terms of its return on assets and buyback yield. Meta has a return on assets of 20.1% and a buyback yield of 4.6%. The industry median return on assets is negative 2.7% and the median buyback yield is negative 2.3%. The return on assets indicates how profitable a company is in relation to its total assets. The higher the return on assets, the more efficient and productive a company is at managing its balance sheet to generate profits.

The company has a Value Grade of C, based on its Value Score of 43, which is considered to be average. Lower scores indicate a more attractive stock for value investors and, thus, a better grade.

Meta’s Value Score ranking is based on several traditional valuation metrics. The company has a score of 14 for shareholder yield, 39 for the ratio of enterprise value to earnings before interest, taxes, depreciation and amortization (EBITDA) and 38 for the price-to-free-cash-flow (P/FCF) ratio, with the lower the score the better for value. The company has a shareholder yield of 4.6%, an enterprise-value-to-EBITDA ratio of 8.8 and a 12.5 price-to-free-cash-flow ratio. The price-earnings ratio is 13.3, which translates to a score of 42.

The Value Grade is the percentile rank of the average of the percentile ranks of the valuation metrics mentioned above, along with the price-to-sales (P/S) ratio and the price-to-book-value ratio.

Meta reported a negative earnings surprise for second-quarter 2022 of negative 4.9%, and in the prior quarter reported a positive earnings surprise of 6.3%. Over the last month, the consensus earnings estimate for the third quarter of 2022 has decreased from $2.704 to $1.983 per share due to one upward and 33 downward revisions. Over the last month, the consensus earnings estimate for full-year 2022 has decreased 13.1% from $11.686 to $10.151 per share, based on two upward and 41 downward revisions.

Snap (SNAP) is a camera company. Its flagship product, Snapchat, is a camera application that helps people communicate visually with friends and family through short videos and images called snaps. Snapchat is its core mobile device application and contains five tabs: camera, communication, snap map, stories and spotlight. The camera is the starting point for creation in Snapchat. Communication allows users to send snaps to friends collectively or individually, through its messaging architecture. Snap map is a live and personalized map that allows users to connect with friends and explore what is going on in their local area and around the world. Stories feature content from a user’s friends, in addition to Snapchat’s community and content partners. Spotlight is a way to share user-generated content with the entire Snapchat community. Its advertising products include Snap ads and augmented reality ads.

Snap has a Momentum Grade of F, based on its Momentum Score of 3. This means that it is very weak in terms of its weighted relative strength over the last four quarters. This score is derived from an above-average relative price strength of negative 2.7% in the second-most-recent quarter, offset by below-average relative price strength of negative 67.6% in the most recent quarter, negative 35.8% in the third-most-recent quarter and negative 31.5% in the fourth-most-recent quarter. The scores are 2, 50, 20 and 10 sequentially from the most recent quarter. The weighted four-quarter relative price strength is negative 41.1%, which translates to a score of 3. The weighted four-quarter relative strength rank is the relative price change for each of the past four quarters, with the most recent quarterly price change given a weight of 40% and each of the three previous quarters given a weighting of 20%.

Earnings estimate revisions offer an indication of how analysts view the short-term prospects of a firm. For example, Snap has an Earnings Estimate Revisions Grade of F, which is very negative. The grade is based on the statistical significance of its latest two quarterly earnings surprises and the percentage change in its consensus estimate for the current fiscal year over the past month and past three months.

Snap reported a negative earnings surprise for second-quarter 2022 of negative 33.3%, and in the prior quarter reported a negative earnings surprise of 385.7%. Over the last month, the consensus earnings estimate for the third quarter of 2022 has decreased from earnings of $0.042 to a loss of $0.034 per share due to 19 downward revisions. Over the last month, the consensus earnings estimate for full-year 2022 has decreased 101.6% from earnings of $0.193 to a loss of $0.003 per share, based on one upward and 21 downward revisions.

The company has a Value Grade of F, based on its Value Score of 89, which is considered ultra expensive. This is derived from a high price-to-free-cash-flow ratio of 88.1 and a high price-to-book-value ratio of 4.52. In addition, Snap has a Growth Grade of C, which is considered average. This is derived from a strong five-year sales growth rate of 59.1% and a strong five-year operating cash flow growth rate of 19.9%. This is offset by a low quarterly earnings growth rate of negative 163.8% and a low five-year earnings growth rate of 6.8%.

Twitter (TWTR) offers products and services for users, advertisers, developers and data partners. Its products and services include Twitter, promoted ads and Twitter Amplify, follower ads and Twitter Takeover. Twitter is a platform for public self-expression and conversation in real time. Its promoted ads include objective-based features that allow advertisers to pay only for the types of engagement selected by the advertisers, such as tweet engagements, website clicks, mobile application installs or engagements, obtaining new followers or video views. Follower ads provide a way for advertisers to build and grow an audience that is interested in their business, product or service. Its follower ads are pay-for-performance advertising priced through an auction. Twitter Takeover appears at the top of the list of trending topics or timeline for an entire day in a particular country or on a global basis. The company sells its Twitter Takeover on a fixed-fee-per-day basis.

Twitter has a Quality Grade of B with a score of 63. The company ranks strongly in terms of its Z-double prime bankruptcy risk score and buyback yield. Twitter has a Z score of 6.86 and a buyback yield of 3.7%. The industry median Z score is 5.15 and the industry median buyback yield is negative 2.3%. This is offset partially by a low return on invested capital of 0.2%.

Twitter has a Value Grade of F based on a score of 81, which is considered to be ultra expensive. The company has a score of 18 for the shareholder yield. The company has a shareholder yield of 3.7%. The enterprise-value-to-EBITDA ratio is 94.2, which translates to a score of 97.

The company reported a negative earnings surprise for second-quarter 2022 of 158.8%, and in the prior quarter reported a positive earnings surprise of 33.3%. Over the last month, the consensus earnings estimate for the third quarter of 2022 has decreased from earnings of $0.202 to a loss of $0.004 per share due to 11 downward revisions. Over the last month, the consensus earnings estimate for full-year 2022 has decreased 32.1% from $1.667 to $1.132 per share, based on nine downward revisions.

Twitter has a Growth Grade of D based on a score of 35. The company ranks strongly with its five-year sales growth rate of 15.0% and five-year earnings growth rate of 15.7%. The company has a Momentum Grade of D, with a score of 34. Twitter has above-average relative price strength in the second-most-recent quarter, offset by below-average relative price strength in the first-, third- and fourth-most-recent quarters.

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The stocks meeting the criteria of the approach do not represent a “recommended” or “buy” list. It is important to perform due diligence.

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