Never mind Snap. Meta and Alphabet are different stories heading into earnings

Published Fri, Jul 22 20223:06 PM EDTUpdated Fri, Jul 22 20224:21 PM EDT

Kevin Stankiewicz @in/kevin-stankiewicz-b5593466 @kevin_stank

Disappointing results from the parent company of Snapchat (SNAP) are weighing on other digital ad stocks Friday, but Club members should be mindful of important differences between companies in the industry. In particular, we're talking about two Club holdings that report quarterly results next week: Meta Platforms (META), which owns Facebook and Instagram, and Google parent Alphabet (GOOGL). Shares of both companies firmly underperformed the S & P 500, with Meta closing down 7.6% and Alphabet finishing lower by 5.6% Snap shares plunged 39%, and a cavalcade of analysts downgrades hit the tape Friday morning. Digital advertising is the main revenue stream for Meta and Alphabet, just as it is for Snap. That doesn't mean the slowdown in advertising spending equally affects those three companies. It's impossible to predict exactly how the quarterly results and guidance from Meta and Google will look next week. But we can recognize the different attributes those two tech titans have compared with Snap, allowing us to contextualize the near-term noise and keep our focus on investing in great companies whose value will increase over the long term. We don't think Club members should head for the exits with the other sellers of Meta and Alphabet. What Snap said Snap warned two months ago its second-quarter results would be rough, and yet sales and earnings numbers still came in below Wall Street's lowered expectations. It's worth noting Snap exceeded forecasts on global daily active users, 347 million versus 344.2 million, according to StreetAccount, but the market isn't paying attention to that. Remember, this is a market that wants actual earnings, not non-financial growth metrics that may one day be monetizable. It is paying attention to Snap's slower-than-expected revenue growth in the second quarter, its lack of third-quarter guidance and plans to "substantially" slow its hiring rate, and all reasons the social media firm said its platform is seeing lower demand from advertisers. Those reasons include increased competition from companies (like TikTok, although management didn't identify it by name) and Apple's iOS privacy change, which went into effect last year. The overall challenging macroeconomic situation, including inflationary pressures, also is hurting Snap. "For example, in some industries where topline growth remains strong, but businesses are experiencing input cost pressure due to inflation, we have observed reduced marketing spending and lower bids per action," Snap said in a letter to investors. On Friday morning, Twitter (TWTR) — another social media player that mostly makes money from digital ads — also reported worse-than-expected results . We're mostly focusing on Snap in this piece, though. The reason is that while the broader economic forces played some role in Twitter's results, the company finds itself in a unique spot because of the Elon Musk takeover saga. Twitter said uncertainty related to that pending acquisition did weigh on results. Of course, it's hard to quantify its specific impact, so we think it's prudent to primarily zoom in on Snap. What it means for Alphabet and Meta Simply put, Meta and Alphabet are just much bigger, more established players in the digital ad market than Snap is. We made this point in May , when Snap issued its negative preannouncement, and it's important to repeat again here. Advertising spending is cyclical, tied to the health of the overall economy. We know GDP growth in the U.S. is slowing considerably — it was negative in the first quarter and could very well be in the second quarter , too. At the most basic level, that is not great news for Alphabet and Meta. Analysts who cover the companies have been revising their revenue estimates lower for the second-quarter — and the third and fourth quarters for that matter. So, we know Wall Street is aware the advertising environment has gotten tougher. However, Alphabet — with its Google Search and YouTube — and Meta's Instagram and Facebook platforms are generally situated higher on the ad priority ladder than Snap, whose popularity is concentrated among younger users. Snap's year-over-year revenue growth rate went from 38% in the first quarter to 13% in the second. The question is, how much will Alphabet and Meta's revenue decelerate? Google's ad revenue rose 22.3% year over year in the first quarter to $54.66 billion. In the first quarter, Meta's ad revenue rose 6.1% year over year to roughly $27 billion. Its overall revenue rose 7%, the first time since the company went public a decade ago that its growth rate was in the single digits. Analysts from JPMorgan summarized the situation well in a note to clients Friday, as they downgraded Snap to underweight from overweight. Here's what JPMorgan wrote (emphasis theirs): "In terms of laterals, we expect all online ad companies to see material macro weakness, w/our view supported by recent cautionary internal memos at both Google & Meta. However, we think the pressure on Snap is greater than on the 2 bigger platforms which have more entrenched budgets, larger scale, & generally higher [return on investment], whereas spending on Snap is relatively earlier stage & sometimes experimental," the analysts wrote. While JPMorgan said it anticipates expectations for Alphabet and Meta to will fall further, the analysts highlight the key differences between Alphabet and Meta. When companies need to tighten the belt, marketing budgets are one of the first places they look. They're unlikely to entirely eliminate spending all at once; rather, they'll want to only allocate their spending to the places with the best dollar-for-dollar return, a dynamic that plays into the hands of Meta and Alphabet. Again, that doesn't mean the companies will be immune from a pullback in ad spending. But it's important to recognize the differences in scale and perceived value Alphabet and Meta have compared to Snap and other smaller social media firms, such as Pinterest (PINS). Another key difference to keep in mind is the financial health of Alphabet and Meta, and the way investors value those companies. They are immensely profitable enterprises, their core operations generate tons of cash, and they buy back large chunks of stock. In April, Alphabet's board signed off on a $70 billion stock buyback program. That came after Alphabet repurchased roughly $13 billion worth of shares in the first quarter alone — almost approaching the entire value of Snap on Friday around $16.4 billion. Meta bought back $9.5 billion worth of common stock in Q1, after repurchasing $44.54 billion in fiscal 2021. Contrast that with Snap, which only turned in its first-ever quarterly net profit in the fourth quarter of 2021. On Thursday, Snap reported it had negative free cash flow through the first six months of this year and its net loss totaled $781.7 million year over the same stretch. As a result, investors value Snap on a price-to-sales basis, whereas Alphabet and Meta are valued on price-to-earnings (GAAP earnings at that, not the adjusted stuff many tech companies report). We've been saying since late last year Club members should stay away from money-losing companies like Snap, as the Federal Reserve started to tighten monetary policy. Instead, we've said look to profitable companies that return cash to shareholders through dividends, buybacks or both. Those characteristics don't guarantee a stock will go up in the near term (nothing does), but they suggest a level of quality and defensiveness that we prefer when the Fed is being aggressive. Plus, at this point, we think Meta and Alphabet's valuations have fallen enough. Meta, in particular, is trading below a market multiple — 14.8 times forward earnings (and that's even before accounting for about $50 billion net cash position ) compared with the S & P 500 at just under 16 times, according to FactSet — but we think it's a better-than-average company. Shares of Alphabet trade at around 19 times next 12 months earnings (before accounting for an incredible roughly $125 billion in net cash), a premium we feel is more than justified given the company's track record of success and favorable long-term future prospects. Bottom line It's no surprise Alphabet and Meta shares are being dragged down by Snap on Friday, but market moves like this require investors to be discerning and lean on their discipline. We were clear-eyed about the ad-market challenges before Snap's report. We think instead of reflexively dumping Alphabet and Meta shares into Friday's weakness, we need to keep our long-term view and wait for these companies to report earnings next week. (Jim Cramer's Charitable Trust is long META and GOOGL. See here for a full list of the stocks.) As a subscriber to the CNBC Investing Club with Jim Cramer, you will receive a trade alert before Jim makes a trade. Jim waits 45 minutes after sending a trade alert before buying or selling a stock in his charitable trust's portfolio. If Jim has talked about a stock on CNBC TV, he waits 72 hours after issuing the trade alert before executing the trade. THE ABOVE INVESTING CLUB INFORMATION IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY , TOGETHER WITH OUR DISCLAIMER . NO FIDUCIARY OBLIGATION OR DUTY EXISTS, OR IS CREATED, BY VIRTUE OF YOUR RECEIPT OF ANY INFORMATION PROVIDED IN CONNECTION WITH THE INVESTING CLUB. NO SPECIFIC OUTCOME OR PROFIT IS GUARANTEED.

A smartphone with Facebook's logo is seen in front of displayed Facebook's new rebrand logo Meta in this illustration taken October 28, 2021.

Dado Ruvic | Reuters