How to be very wrong: Meta’s cash alocation nightmare

Meta’s stock crashed in 2022. The sales dropped in 2022 for the first time since it went public. And Meta is heavily investing in the metaverse. The stupid metaverse boom finally collapsed, and the investment makes no money, seems like dumping Facebook money. Also, the tech stock crash happened in 2022, so it got a royal straight flush of stock dumping pressure. The stock price went down from $360 to $90 (1/4th). But the stock price went up after that to $500 (more than a 5 times surge).

 I think Zuck (Zuckerberg) can’t abandon the meta investment, he has already spent more than $30B (billion). I understand it is difficult to cut losses, but Zuck you should be brave. The metaverse can be something useful after you spend more than $300B, but nobody knows.

A good investment is about buying cheap, I mean you should get way more return than the investment. For example, which is a better company?

Company A: you can buy it at $100, the company generates $40 every year, so you can retrieve the investment within 3 years.

Company B: you can buy it at $300, the company generates $30 every year, so it takes 10 years to retrieve the investment.

Obviously, company A is better as it takes a shorter time to retrieve the investment. My definition of a good investment is one where you can retrieve your investment in the short term like 3 to 5 years. It isn’t profit, but retrieving it as cash. Actual cash flow and profit are very different. For example, if a company generates $100 as profit, but it has to add a $100 machine every year to keep up with the competition, there is 0 cash flow. This is not a good investment. Good profit must bring cash.

So, from my standard, the metaverse investment is the worst. Nobody knows if it will make cash or not, let alone when it will make cash!

They have no clue when to retrieve the investment. The “brightest” guys are spending $50B without knowing when to collect, and even the possibility of getting a return is unknown, just insane.

A company’s goal is about getting future cash flow. That means past net income is nothing. Even if the company was very profitable in the past, that doesn’t guarantee future profit. A competitive advantage (I call it a Unique Selling Proposition (USP)) brings competitiveness in the future if the USP is still valid in the future. The situation changes. In many cases, once a valid USP doesn’t work anymore (like Toys ‘R’ Us was once the most convenient toy shop but went bankrupt after e-shopping flourished), that is why so many companies stop operating. Only a tiny amount of companies can survive for a very long time.

A USP brings a thick profit margin, but it is not enough. Even if the company makes a profit, if it doesn’t make cash, it doesn’t mean anything. Great companies must make operations leaner and generate surplus money, making their balance sheets stronger. They should invest heavily in cash-making businesses and acquire more future cash.

Profit doesn’t pay, cash does. Many people can’t tell the difference between cash flow and profit. They think both of them are almost identical. As I explained, if your business operation constantly requires scaling cash every year to just maintain the business, you can’t get the cash out of the business for the future. That often happens when the gross profit margin is thin.Thick profit is merely one of the many components of thick cash flow.

In 2022, Meta’s stock went down really badly. The price-earnings ratio (PER) became less than 10. PER is calculated by stock price ÷ net profit per stock. This means you can retrieve your investment within 10 years. Very low for an IT company. Meta’s sales declined in 2022 because Facebook’s advertisers were not comfortable spending money when a recession was on the horizon. This recession fear was caused because inflation was persistent, and the FED tried to cause an artificial depression to tame inflation. The depression didn’t actually happen, but the stock market plunged in 2022. The sales went down, but it was not permanent. When the recession fear becomes all clear, the advertising sales will go up again. That is quite apparent. So the PER should be at least 20. A PER of 10 was too cheap. Not only that, Meta spent $38 Billion on Research and Development in 2023, and the immediate need for Facebook, Instagram, and WhatsApp seems like less than $20 Billion. So if they stop spending money on the stupid metaverse (they can do so whenever they want), the earnings per share can easily reach $17, and the PER was virtually around 5.

Meta was dumping an absurd amount of money on the metaverse, but it still has a great cash-making cow: Facebook. Facebook’s Unique Selling Proposition (USP) to users is that it has the largest user base on Earth. It is so convenient, everyone is on it, and not participating in it is like not having a phone. No other company can emulate Facebook. To advertisers, Facebook is the only platform where they can target clients directly, as Facebook has a lot of client data. No other platform provides this. On other platforms, you can’t reach aimed targets, it costs a lot to get to the target.

Facebook was making huge profits and cash, and it will in the future – a great business. One should have bought it at a PER of 10.

By the way, do you know about treasury stock? When a company buys its own stock, it is called “treasury stock”. The point of this is to reduce the stock amount to increase investors’ share. It is kind of an investment, even though it is on the cash flow statement’s financing activity. It is an investment because it will enhance the company investors’ future returns. For example, a company issued 100 stocks in total, and the profit is $100 each year. The profit per stock is $1. The stock price became so cheap the stock price is now only $5. That means the PER is 5 ($5÷ $1 (profit per stock)) .

Suppose there are 2 options for the company:

a. Buy back stocks for $150
b. Invest in a business for $150 that will make a $20 (13%) return.

a. The company decides to buy back 30% of stocks for $150. Now, only 70 stocks will be available, so the profit per stock becomes $100 ÷ 70 = $1.42. The total return a year is (1.42-1)*70stocks=$30. This is a 20% return on the $150 investment.
b. The company invests in the business. The profit becomes $120.

Not only that, when companies net profit grows twice to $200, the yearly return of stock buyback will be $60 and the return on the $150 investment would be 40% a year. the b. investment return doesn’t change still 13%.

So that is why when the stock price plunges, a good company buys back stocks using accumulated cash from operations or even uses debt (if the interest rate is low and fixed), taking advantage of the situation.

Meta bought back treasury stock in 2022 when the stock price went down. The cheaper the buying price, the better, because they can buy more stock for the same amount. In 2022, they bought back stocks at an average of $173, which was 6% of all stocks. This is a great decision even though the bottom was $90. Nobody knows the bottom price. After that, the price became $500, so they bought it at a very cheap price. Well done Zucky. The company demonstrated that the managers thought the stock price was too underrated, so the price would go up.

Now the stock price is $500 (Mar 2024), and the PER is around 33. Even CEO Mark Zuckerberg is selling his own stock, he thinks the stock is surging too much for no reason.

I think Meta should abandon the metaverse and become a dividend company. By abandoning the metaverse, it can reduce its R&D cost significantly. Meta has a cash-making cow Facebook, so it should give away all the cash Facebook earns. The only way to contribute to investors in this situation is to pay dividends. The metaverse investment is making no cash, and stock buybacks only work well when the stock price is low. There are no good companies to buy for M&A. Also, It can keep accumulating cash for the situation when the stock price plunges (to buy back the stocks) or purchase a big profitable business.

These days, Meta decided to pay dividends for the first time. Investors celebrated this decision, and the stock went up. Everyone seems to think Meta should abandon the metaverse and become a dividend company.

The exact opposite of the worst investment is Nvidia’s AI investment. Nvidia shifted its focus from gaming graphics to AI and invested heavily, which led to great success. That doesn’t seem to be happening to Meta.

To me, Meta is half-assed. If they wanted to be a dividend machine, they should just keep the cash generated by Facebook and pay all of the money it has. Don’t play with the hard-earned cash on the metaverse. If they want to be a metaverse company, they should put all the money from Facebook into the metaverse and focus on it. Don’t think about investors’ requirements; just focus on the metaverse. Of course, the stock would plunge, and investors would think it’s insane. Then you can get a chance to buy treasury stocks! They shouldn’t care about paying dividends if they truly believe the metaverse is the way of the future. They bought back stocks when the stock crashed, which was great, but if they had kept the hard-earned cash, they could have bought way more stocks. The company was not patient; they bought many of their own stocks at $330 in 2021 too, which was not so cheap. The company wasted a lot of money on the metaverse and an unnecessary amount on high-salary employees.

Zuck, don’t be half-assed.

The biggest problem with Zuckerberg’s risky investment in the Metaverse is that he does not receive any feedback or indications about its progress. Unlike companies like Nvidia, which carefully monitor the development of AI technology, Zuckerberg should have closely observed the overall progress and adoption of the Metaverse concept before investing heavily in it.

But he just relies on his instinct and spends money limitlessly. Because you have money, you use it like toilet paper and flush it away. That is not cool DUDE! You should use money more carefully. Spend a little money, see the indication, get a good sign, then OK, use more. But do not throw investors’ money like that, Zuck!

Of course, if in the future, many more people adopt the metaverse, it can be very big. However, there can be a future where Meta spends $200B on the metaverse, and still, people are not interested in it at all. But Meta can’t abandon the metaverse because it means admitting it failed, and it has already spent $200B, so if you stop it, you lose everything you spent. You can’t cut your losses.