Today’s menu

• Revenue model - how do they make money?

• Competitive advantage - network effects

• Market size

• Financial analysis

• Stock purchase

• Conclusion

Revenue model

Meta Platforms (Meta) has two revenue segments. The first is called Family of Apps, which includes all the social media apps - Facebook, Instagram, Whatsapp and Threads. The second is called Reality Labs. Family of Apps is all that matters for Meta, because it generates 98.6% of revenue and all the profits. Reality Labs looses money.

Meta earns revenue by allowing users to sign up for social media platforms for free, then they charge advertisers to display adverts to those free users.

Meta is a big advertising business and you, the users, are its product.

Competitive advantage

There are different types of competitive advantages that businesses can possess. Warren Buffett calls them “economic moats”.

The reference to economic moats is an analogy between companies and castles. Castles used to have moats around them to keep marauders away. A moat prevented attackers from getting to the castle walls and climbing over them. Similarly, companies need economic moats around them to keep competitors away.

In the social media business, the main type of competitive advantage is known as a Network Effect. Network effects occur when the value of a service increases because the number of users increases. The increase in value then causes the network to grow further. The larger the network, the stronger the competitive advantage the company has.

Businesses with network effects face a problem called the cold-start problem. In the initial phase of the business, if the network does not grow fast enough to become valuable, users will leave the network. However, once critical mass is achieved, the network grows organically and often through word of mouth. When critical mass is achieved, it becomes very difficult for competitors to challenge the incumbent.

Markets dependent on network economies are often winner-take-all markets. The network that can achieve scale first, wins. This makes scaling an important factor because at a certain point, the cost of winning market share is too high and competitors give up.

In summary, the key factor that determines competitive position with network effects is the size of each company’s installed base. The larger the installed base, the greater the ability of the company to capture higher returns.

Market size

There are many social media networks out there, how does Meta stack up?

As it turns out, Meta is the biggest of them all.

Here’s a table of monthly active users for the most popular social media networks. The total number of users on social media networks is 20 billion. There are only 8.2 billion people in the world, so clearly people use more than one network or have multiple accounts.

Six networks have more than one billion users and Meta owns three of them. Here are the number of monthly active users that the largest companies can reach:

• Meta – 8.3 billion users (41%)

• ByteDance – 2.44 billion users (12%)

• Alphabet – 2 billion users (10%)

• Tencent – 1.37 billion users (7%)

Meta has 3-times more active users than its closest competitor. That gives it a huge advantage over everyone else. In a business where size of network matters, Meta dominates.

Financial analysis

But what do the numbers say?

The numbers say that Meta is Extraordinary:

• ROCE is over 28%, which is extremely high. Rule of thumb - above 15% is good.

• Gross margin is above 80%. This is very high, but also to be expected for a company that has a software product.

• Growth in revenue averages above 20%. Very high.

• Stock-based compensation is about 30% of free cash flow. This is high and not a good thing. We explained this before, read it here.

• Debt levels are reasonable.

• Valuation - with a free cash flow yield of 2.4%, Meta is not cheap, but it is cheaper than many other tech companies.

Stock purchase

On Friday, we purchased Meta stock.

Friday was actually a bad day for Meta's stock price, it fell 4.3% over the course of the day. That is not an important fact, even if the news commentators would have you believe otherwise. The one-day stock price movement means very little.

Meta is the tenth stock in our portfolio.

And no, I haven’t rebalanced the portfolio, which is why Nvidia and Novo Nordisk are such large holdings. I’m in no rush to get rid of great companies. In the meantime, the portfolio will naturally adjust as we add other positions.

Conclusion

Meta is an Extraordinary Company. It has a strong competitive position and the numbers show the financial benefit from that.

Stock prices have been volatile lately. Meta’s stock price might drop further after our purchase, but that is okay. It is better to buy when the price is dropping than to wait for it to climb and pay more.

I haven’t rebalanced the portfolio and that is fine. As private investors, we can afford to behave like the owners of businesses and not like portfolio managers. On average, portfolio managers turn over 70% of their portfolios per year. That means it takes them a mere 17 months to buy and sell every company in their portfolio.

In contrast, as Extraordinary Investors we like owning the best companies in the world. That is why in almost 4-years, we have only sold one company from the portfolio - Coca Cola Consolidated - and it would have been fine if we had kept it. We’re not traders, we’re not playing the financial markets, we are owners.

Look at our collection of companies, it's a handsome bunch with superb financial characteristics. That is what matters in the long-run, even if stock prices drop in the short-run.

It’s hard to keep the owner mindset when the market is falling, but this is one of your biggest advantages over professionals, so use it wisely. We talked about how to be an Extraordinary Investor here.

I would like to hear what you’re up to.

DM me on social media or email me.