Down 10% This Year, Will Gen AI Tools Help Apple Stock Recover?

Apple (NASDAQ:AAPL) stock has had a tough 2024 so far, declining by about 10% year-to-date, underperforming its big tech peers as well as the Nasdaq-100, which has gained about 9% over the same period. So what are some of the reasons for the decline in Apple stock? The biggest concern appears to be surrounding iPhone demand in China, the world’s largest smartphone market. Per Counterpoint Research, iPhone sales in China declined by 24% over the first six weeks of 2024, compared to the Chinese smartphone market which declined by 7% over the same period. Apple has been resorting to discounts to prop up sales and better compete with the likes of Huawei, who has been gaining ground in the high-end of the market. There is a possibility that the iconic device is seeing slower sales in other markets as well, given that iPhone contract manufacturer Hon Hai Precision reported an 18% slump in sales over the first two months of 2024.

Investors might also be concerned about Apple’s longer-term growth prospects. Apple launched its Vision Pro mixed reality headset a little over a month ago. While early reviews praised the futuristic device as being polished and innovative, it is increasingly apparent that the device is unlikely to move the needle for Apple’s revenue growth and profitability anytime soon given its high sticker price of $3,500 and limited use cases. Apple also abandoned the development of its self-driving car, which it spent nearly a decade working on. This isn’t giving investors much confidence about what will likely drive Apple’s next big wave of growth. Over Q1 FY’24, Apple’s revenue rose just about 2% year-over-year to $119.6 billion, with earnings standing at $2.18 per share, with services emerging as the biggest driver of growth, while the iPad and wearables businesses saw declines. There are concerns on the services front as well, with new European Union laws forcing Apple to effect major changes to the App Store and parts of its iPhone operating system in the region. Apple will now need to allow users within the EU to buy and download apps from outside of its App Store as well. While Apple has implemented new fees on apps downloaded outside the App Store, the regulatory risks are still noteworthy for investors.

Looking at a slightly longer period, AAPL stock has shown strong gains of 35% from levels of $130 in early January 2021 to around $175 now, vs. a similar change for the S&P 500 over this roughly 3-year period. However, the increase in AAPL stock has been far from consistent. Returns for the stock were 35% in 2021, -26% in 2022, and 49% in 2023. In comparison, returns for the S&P 500 have been 27% in 2021, -19% in 2022, and 24% in 2023 – indicating that AAPL underperformed the S&P in 2022. In fact, consistently beating the S&P 500 – in good times and bad – has been difficult over recent years for individual stocks; for other heavyweights in the Information Technology sector including MSFT, NVDA, and AVGO, and even for the megacap stars GOOG, TSLA, and AMZN. In contrast, the Trefis High Quality (HQ) Portfolio, with a collection of 30 stocks, has outperformed the S&P 500 each year over the same period. Why is that? As a group, HQ Portfolio stocks provided better returns with less risk versus the benchmark index; less of a roller-coaster ride as evident in HQ Portfolio performance metrics. Given the current uncertain macroeconomic environment with high oil prices and elevated interest rates, could AAPL face a similar situation as it did in 2022 and underperform the S&P over the next 12 months – or will it see a strong jump?

We value Apple at about $183 per share, which is 6% ahead of the market price. Although Apple stock trades at about 26x forward earnings, a bit higher than historical levels, we think the stock is slightly undervalued for a couple of reasons. Apple has done a good job of boosting its margins. Over Q1 FY’24, gross margins rose to 45.8%, up from about 43% in the year-ago period, likely driven by more favorable product mix skewed toward high-end devices, higher services sales, and lower component costs. Apple also has a big opportunity in the generative AI space. While Apple has avoided making big announcements on the AI front over the past year, following the success of ChatGPT and similar tools, unlike rivals such as Microsoft and Facebook, we believe Apple could be a big winner in this space for a couple of reasons. Unlike most companies that use public data, large language models, and high-power GPUs, Apple has a unique position in terms of implementing AI on-device, while keeping user data private. The company has the best in class mobile processors which could give it an advantage in more personalized, end-point AI applications.  See our analysis of Apple Valuation for more details on what’s driving our price estimate for Apple and how it compares with peers.

[1] Returns as of 3/12/2024
[2] Cumulative total returns since the end of 2016

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