The next big platform may not be the next iteration of Apple’s (NASDAQ:AAPL) iPhone but rather artificial intelligence (AI), as the platform, itself. Very few could have predicted 30 years ago that we’d have almost every technological gadget known to humanity in the palm of our hand with the iPhone – from email to an advanced camera to social media and beyond. Today, we wonder if many can see a world that is heavily influenced by AI, not only in our everyday, personal lives but also with respect to our work.
Will AI know what we want for dinner and order it for us for delivery before we even think we want it? Will AI already do our job before we even enter the office? It’s hard to fathom a world today, where technology could eventually be developed that may possibly anticipate and replace our decision-making, for the better, but it’s possible. Look at how computers have changed the world and how we work, and then of course, big data and how that has optimized just about everything in our lives. AI may very well be the future.
Will Apple Be Left Behind?
Microsoft (MSFT) has perhaps made the biggest splash with respect to its AI endeavors with its investment in OpenAI’s ChatGPT, which has set in motion a race among big tech firms. Alphabet (GOOG) (GOOGL) is rolling out Bard, which is its own conversational AI service, but AI may do more to cannibalize Google’s search technology than anything else.
Google relies on businesses to pay to rank at the top of its search pages, and the search giant having to integrate AI into the mix may only create more costs with little return. Unlike Google, however, Microsoft has an open pathway to growth with its search engine Bing should AI-driven search technology take off. Google may be able to integrate AI effectively in Gmail and Docs, however, but we’re not sure how it will make the firm more competitive in these areas.
Nobody truly has all the answers right now because the reality is that the early iterations of AI won’t be the end game for the technology. There have been a number of stumbles out of the gates as companies have rolled out AI to the public over the past few months, but with any new technology, this can almost be expected. The first iteration of any new product is almost always full of flaws that will only be refined and improved later, with further enhancements and feedback from customers.
For Apple, which dominates the delivery platform of current technologies in the iPhone, the long-term outlook isn’t as clear. Will we even need an iPhone ten or fifteen years from now, or will there be a new “hardware” interface that best fits AI, and will the best AI win regardless of what “hardware” it is in? Is the future more about dominating the AI landscape than producing its “hardware” deliverable? Apple has a tremendous product suite, installed base, and ecosystem at the moment, but as we look through time, think about all the technologies that have come and gone from the Blackberry to the Moto Razr – to even the fax machine.
We think AI will continue to be an area of huge investment for large-cap tech firms, and maybe even for smaller ones, too. TechCrunch noted that Apple could potentially be working to integrate AI into Siri and language-generating AI, and perhaps this is how the company will stay in the AI game and maybe even prosper in this area, but according to the same report, Siri has had its share of difficulties failing to understand different accents and phonetics. Nobody knows what the future truly holds, but AI will be a large part of it, and right now, despite all that we’re hearing from other firms, we think Microsoft has the clear lead with its investment in OpenAI.
Apple Still in the Game
With this said, the one thing that we have always counted on when it comes to Apple is that it is a continuous innovator. The company could have very easily been a one-hit wonder with just the iPod, but it leveraged that technology across the board with iPhones, iPads, and you name it, to become the behemoth that it is. But the game will be a different one in the coming decades, in our view, and while we are not building in too much disruption in Apple’s business model in our valuation framework, using a margin of safety with respect to Apple’s valuation may be more important than ever these days.
We value each company via a discounted cash flow model, which considers the net cash position on the balance sheet and the present value of all future expected free cash flows. We estimate Apple’s fair value at about $140 per share. This is the highest part of the fair value distribution. It’s important to note that every company has a range of probable fair values that is driven by the uncertainty of key valuation drivers. Some of these key valuation drivers are future expected revenue growth and future expected mid-cycle expectations.
After all, if the future were known with certainty, we wouldn’t see much volatility in the markets as stocks would trade precisely at their known fair values. What this means is that if we knew exactly what interest (discount) rates would be in the future, and exactly what a company’s future free cash flows would be, there’d really be no reason for share price movement. Everybody would know what the company would be worth and that would be the fair price to pay for the stock.
Because the future is inherently unpredictable, however, it’s important to view valuation as a range of probable fair value outcomes. For example, stocks with huge uncertainty in their future expected free cash flows have a large fair value estimate range, while steady-eddy firms may have a small fair value estimate range. In the graph above, we show this probable range of fair values for Apple.
We think Apple’s stock is attractive below $112 per share (the green line), but quite expensive above $168 per share (the red line). The prices that fall along the yellow line, which includes our fair value estimate, represent a reasonable valuation for the firm, in our opinion. However, there’s more to this fair value probability distribution than that. The fair value estimate range is also very important as a conceptual framework. Apple is trading at the high end of the fair value estimate range at the moment (at ~$166 per share), so one might view Apple’s shares as fully-priced at this time (note the high end of the range is $168 per share). The low end of the fair value estimate range could be viewed as perhaps a scenario in which Apple is disrupted by AI, and normalized results experience a step-down. A reasonable fair value under such a scenario may be ~$112 per share.
In any case, thinking about valuation as a range of potential outcomes is extremely valuable for the investor.
Nobody can truly predict how artificial intelligence will change the world, but Microsoft looks like it has an early lead. That may mean the markets may have to take a closer look at Apple’s valuation because if Microsoft comes out with a killer app, the “hardware” that it is on could become an afterthought. However, Apple is still very much in the AI game, and it has shown time and time again that it can innovate to stay ahead of the pack. We also love that Apple retains a considerable net cash position on the balance sheet, has tremendous free cash flow generation, and among the best dividend growth prospects in our coverage. All that said, however, shares of Apple are trading at the high end of our fair value estimate range, and that may mean meaningful risk to the downside, even if the company stays comfortably in the AI race via Siri or another deliverable. Seeking Alpha