Apple Gets AI Right

Summary:

• Lately we’ve been seeing investors push AI stocks to remarkable highs.
• Ever since ChatGPT became the fastest app to reach 100 million users, investors have been scrambling to buy publicly listed AI stocks.
• Unfortunately, the AI game is a little different for big tech than for medium sized companies like OpenAI.
• Big tech companies have more to lose from getting AI wrong compared to smaller startups.
• Apple is playing this game better than other tech companies as it is approaching the matter more cautiously than others.

This past month witnessed many tech stocks rise or fall on the basis of their moves in the artificial intelligence (“AI”) space. It all started when ChatGPT became the fastest growing app in history, which was followed shortly by a major rally in Microsoft (MSFT) shares on news that it bought a $10 billion stake in OpenAI. Later, NVIDIA (NVDA) rallied after it beat earnings and raised its guidance thanks to AI chips.

Conspicuously absent in all of this AI talk was Apple (NASDAQ:AAPL). The world’s largest company by market cap, it’s among the smaller tech companies as measured by public statements about AI. In its most recent earnings call, Apple only mentioned AI two times, compared to 74 for NVIDIA, 62 for Alphabet (GOOG) and 37 times for Meta (META).

Compared to NVIDIA’s massive AI-fuelled rally, Apple’s stock performance has been subdued lately. Over the last month, the stock is up only 2.3%, compared to 13% for NVDA. Obviously, Apple is not perceived to be an “AI winner” stock (assuming my theory about what’s driving NVIDIA’s gains is correct).

However, Apple might actually be making the right moves in the long run. By taking things slowly with AI, it is allowing other companies to demonstrate where the risks and opportunities lie, enabling Apple to move in later on when the correct approach is clearer. Apple is well known for taking its time to enter new markets. When the original iPod launched, MP3 players were already an established product category; Apple waited to see what everybody else was doing before jumping in. The end result was the launch of what would become the world’s most popular music player for many years. We’re seeing a similar strategy today. Apple recently put the brakes on BlueMail, an e-mail app that uses GPT to compose emails. The app was allowed to move forward only on the condition that it was limited to users 17 years of age or older.

The BlueMail move was smart because it showed that Apple is aware of one of the issues with AI: liability. AI applications sometimes create content that is objectionable. For example, Bing’s chatbot has been known to insult users. The legal implications of this content remains a grey area, but when uncertainty like this abounds, it pays to wait. For this reason, I believe that Apple actually has one of the best approaches to AI among all the major tech companies, one based on prudence and care, rather than quick and potentially reckless deployment. AAPL taking things slowly with AI does not mean that the company will never have any AI products; to the contrary, it already has several, and its cautious approach to chatbots could easily save the company money going forward.

Apple’s Many AI Investments

Before going any further, I need to debunk one popular misconception about Apple and AI: the claim that Apple isn’t doing anything in the AI space. Nothing could be further from the truth. Apple has many products that use AI, including:

• Face ID – a wildly popular facial recognition security feature used mainly in the iPhone.

• Notes – a note taking app that incorporates handwriting recognition.

• The app store – uses AI for providing recommendations based on the user’s download history.

As you can see, there is no shortage of AI investment at Apple. To the contrary, AI is being actively incorporated into many of the company’s products. What Apple is taking slowly is simply one AI use case, which is “large language models,” the technology behind ChatBots like ChatGPT. There are many good reasons for Apple to avoid rushing into this space. For one thing, text applications have never been Apple’s Forte, Pages has barely any market share and Apple has never had its own in-house search engine. Second, Chatbots are risky. It’s fine for OpenAI to release a ChatBot to the public because it’s a relatively small tech company that doesn’t do much other than sell AI models. But if you take a big company and start shoving chatbots into its products, risks begin to emerge. Inaccurate information, bullying of users and even threats have been cited as some problems with Microsoft’s Bing Chatbot. Lawyers continue to debate what the implications of inaccurate replies and abuse in ChatBots will be–some say that big tech is covered by Section 230, others argue that it doesn’t apply to content the company itself created. As an investor, what you need to know is that there are legal risks present in this race to rush out AI ChatBots, and Apple is wise to play it safe here.

Apple Could Save a Lot of Money

There is one very obvious and real way in which Apple’s conservatism with ChatBots could pay off:

It could create cost efficiencies.

LLMs are known for being very costly to run. Morgan Stanley once estimated that if Google implemented a ChatGPT like Chatbot, it could cause a $6 billion hit to operating income (“EBIT”). The problem is that Chatbots are very resource intensive and use up a lot of computing power. If you can avoid having a Chatbot application in your product line and remain popular, then you save money by not having one. So, Apple could potentially save a lot of money relative to companies like Microsoft, and enjoy higher margins.

Valuation

Having looked at where Apple stands with respect to AI, it’s time to explore the stock’s valuation. We’ve seen already that Apple is actually making a good move by taking things slowly with AI, rather than a bad one. Still, that on its own does not make its stock a buy. If a company saved $50 billion by avoiding unwise AI investments and was overvalued by $100 billion, it would still not be a buy. Nothing deserves an infinite price. So, let’s take a look at Apple’s valuation compared to its competitors.

Going by multiples, Apple is pretty middle of the pack for FAANG stocks. Below, I’ve reproduced some multiples for Meta, Google, Apple, Microsoft and NVIDIA, courtesy of Seeking Alpha Quant.

	Meta	Google	Apple	Microsoft	NVIDIA
P/E (adjusted)	21.5	20.66	25.6	28	137
Price/sales	4.3	4.3	6.3	9.3	22
Price/book	3.85	4.7	39	10.4	26.66
Price/operating cash flow	9.5	13.1	21.2	22.5	104

Click to enlarge

As you can see, Apple is right in the middle of the pack for all of the earnings and cash flow based valuation ratios. It does have the highest price/book ratio, but that metric is mainly used for identifying cases of truly extreme undervaluation–none of the stocks in this peer group are anywhere near that category, so we could say that that ratio isn’t applicable to this peer group based valuation.

Compared to its peers, Apple looks to be “modestly” valued. That is, assuming that all of the companies involved have comparable growth and profits in the future. AI might change that. If Microsoft and Google go head to head in an AI chatbot war, then Apple may enjoy better margins than either company by side stepping the AI arms race. If so, it may command a premium.

The Bottom Line

The bottom line about Apple is that it is doing the right thing with AI: playing it safe. If you watched Microsoft and NVIDIA’s big AI-fuelled rallies, you might think that this sounds like a questionable point, but it’s not. For one thing, MSFT gave up much of its AI gains after the Bing controversies became publicized. For another thing, the legal aspects of AI, including laws surrounding copyright and user abuse, remain to be seen. If AI content isn’t covered under Section 230, then companies could be held liable for abusive content. As a non-lawyer, I can’t comment on what’s likely to happen here, but I can say that there are legal experts on both sides of the debate.

So, Apple’s “safety first” approach may win out in the end. We’ve seen companies’ reputations rise and fall in the blink of an eye based on AI hype and fear. It’s not exactly clear what long term impact all of this will have on corporate earnings. We know for a fact that inserting AI into search increases server costs. We also know that AI-driven stock market rallies don’t always last. The long run effect of all of this AI hype is unknown. What is known is that Apple’s “late entry” strategy paid off in the past. Perhaps it will pay off in the era of AI as well.

For my part, I’m comfortable holding Apple stock. It’s profitable, it has a strong brand, it tends to grow in most quarters, and it has a smart management team. Obviously, at its current size, AAPL isn’t the kind of stock that’s going to make anyone rich overnight. But it could be a good store of value and vehicle for long-term savings.

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Disclosure: I/we have a beneficial long position in the shares of AAPL, GOOG, META either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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