Apple | Fundamental Analysis

Just when investors thought Apple shares might be losing momentum, the company's developer conference gave the stock a significant boost. The unveiling of a host of upcoming products and features leveraging artificial intelligence (AI) pushed Apple to new highs.

Apple stands out as a leading AI stock because generative AI aligns seamlessly with the core experience of using iOS products. The key question for potential investors is how much more upside the stock has. Is Apple still a buy? Here's what you need to know.

AI is a major focus for Apple. The company recently introduced a slew of AI features to be integrated into its software, including custom emojis, ChatGPT integration with Siri, and its proprietary AI technology, Apple Intelligence. These innovations could greatly enhance the user experience on iOS devices, an area where Apple already excels.

After years of limited functionality, many users, myself included, are eager for an improved version of Siri. It's likely that others feel the same way. Enhancements in iOS devices through AI will likely make the Apple ecosystem even more compelling. In other words, AI appears poised to strengthen Apple's primary business of selling iOS devices and services.

The impact of AI on Apple will be crucial in determining whether the company can revive its sales growth. As shown in the chart below, Apple's revenue has peaked and started to decline in recent years. While new iPhone models are released annually, the year-to-year changes are not as dramatic as they were a decade ago, signaling the product's maturation. Incremental updates to the camera, screen, and processor have limited impact.

Additionally, Apple's reputation for excellent build quality means users are in no rush to upgrade their phones. It's estimated that 61% of iPhone owners wait at least two years before upgrading.

Encouraging more iPhone users to upgrade could reignite revenue growth, and AI might be the key driver. AI features are arguably the most significant advancement for iPhones since the introduction of the first 5G model, which triggered Apple's last growth surge. Only the latest iPhone models, the iPhone 15 series, will support these AI capabilities. Whether consumers will be motivated to purchase new devices remains to be seen.

Wall Street appears confident that AI will bolster Apple's growth, as reflected in the stock's recent surge to all-time highs following the announcement of its AI initiatives. However, this optimism comes at a cost: Apple's stock now trades at a forward P/E ratio exceeding 33, the highest in recent memory.

A stock's valuation often mirrors expectations. Over the past decade, Apple's average P/E ratio has been around 21. This significant deviation from the norm signals that Wall Street has high expectations, essentially saying, "Deliver the goods!"

While AI holds promise, the expectations are substantial. Analysts predict just a 10% annual earnings growth rate over the long term, which seems insufficient to justify Apple's current stock price. Even if Apple meets or exceeds these expectations, the potential for additional gains for new investors remains questionable. Conversely, if AI fails to significantly impact Apple's business, the stock could face a sharp decline.

In reality, the AI hype has set Apple stock at a premium. The potential for the stock to decline outweighs the likelihood of significant gains, even in a best-case scenario. While Apple customers can anticipate exciting AI developments, investors might be better off waiting for a more reasonable share price.