Manufacturing the AI Consumer

Apple Inc.

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Good morning investors 👋,

Happy Monday.

What better way to start off a week in the markets than a good ol’ stock analysis on a company that more than likely manufactured the device you’re currently holding? My apologies to Android users, but this company is Apple.

Everyone knows Apple, some even love Apple. Whether or not you own one of their products, you’ve most definitely heard the name. In fact, as of 2024, Apple’s brand is worth over $1 trillion¹, and last week, they finally showed investors (and the market) their artificial intelligence plans at WWDC24.

… Apple shares then surged 12% in the course of two days, overtaking Microsoft to become, yet again, the most valuable company on God’s green earth.

There’s been a lot of posts, hype, and talk about the company recently, and considering it’s one of my biggest positions, I thought I’d share a quick analysis on the stock, as well as my personal thesis, and why the company will always remain in my portfolio.

Let’s get into it. (14 min read)

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Today at a glance:

1. Manufacturing the AI Consumer

2. Apple’s Moat: Their Ecosystem

3. Apple Intelligence and the Apple AI strategy

4. Valuation; Is AAPL stock a ‘buy?’

5. Get $1,200 worth of Apple gift cards

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Manufacturing the AI Consumer

Apple AAPL 0.00%↑ sells smartphones. I know, what a surprise, but that really is their main business. As of the most recent (full-year) earnings report, nearly 60% of Apple’s total revenue is from iPhone sales with the remainder mostly a mix of iPad, MacBook, accessories, and a booming service business revenue. (Fun fact: Apple has 1 billion paying subscribers globally on their service business that brought in $23.1 billion of revenue last quarter.)

During the many years following the release of the iPhone in 2007, Apple experienced amazing growth as the technology of the smartphone and innovation grew dramatically every year along with smartphone adoption. Even looking back as ‘recent’ as 2019, that period of growth had not slowed down. Now, in 2024, this innovation has hit a breaking point. Apple has struggled in the past three years to provide enough reasons for customers to upgrade from their old iPhones. When I say ‘struggle,’ I mean a 3% drop in revenue year-over-year and stagnation in revenue over the past three years. This isn’t just limited to iPhones, but all of Apple’s products; products that have hit a plateau without much improvement to capture sales from existing customers via upgrades.

Up until WWDC24, the market had a very bearish view on Apple, with Apple shares dropping as low as 10% year-to-date, and remaining flat for over a year. As all of ‘big tech’ was releasing AI features, chatbots, large language models, and even AI chips, Apple was behind on the innovation — again.

Long-time investors or watchers of the company will know this isn’t out of the ordinary for Apple: Apple doesn’t pounce on trends, they don’t strive to be the first player in an industry, and they never are the first to release a product in an industry. This is why Google GOOG 0.00%↑ Glass and the Amazon AMZN 0.00%↑ Fire Phone failed, and why Google’s Gemini was generating photos of African George Washingtons and Chinese Nazis. Both Amazon and Google in these scenarios jumped on a trend or a new market as quickly as possible without proper due diligence, and failed. This is usually fine, because tech companies power our world’s innovation, but this isn’t Apple’s culture.

Apple takes existing products, spends time revising and perfecting them, until branding that product and marketing it successfully — nearly perfect every single time. The Vision Pro wasn’t the first VR headset, and the iPhone wasn’t the first smartphone. This applies to the iPad, MacBook, AirPods, and every single Apple product over the course of history.

“Our objective is never to be first, our objective is to be best” - Apple CEO Tim Cook

Then comes the moat of Apple — the competitive advantage. While Samsung ($SSNGY) sells devices, Apple sells an ecosystem.

Apple’s Moat: Their Ecosystem

Apple’s ecosystem is unmatched by any other. It’s so good, that the Department of Justice is suing Apple because of it.

With just the purchase of an iPhone, Apple slowly digs a trench around the consumer by offering other products that work either exclusively or seamlessly with the iPhone, such as the Apple Watch, AirPods, MacBook, and iPad. If you own an iPhone and want a smartwatch, the Apple Watch is designed to work perfectly with it. If you want a tablet, the iPad will work seamlessly with your new Apple Watch and your iPhone. Want a tracker for your stuff? There’s AirTag. Want Bluetooth earbuds? There’s AirPods. How about a computer, music streaming app, streaming service, or streaming box? Well, you’re in luck. There’s MacBook, Apple Music, and Apple TV that (you guessed it) work seamlessly with your existing devices.

Keep in mind, these additional products and services aren’t the first and only of their kinds. There’s Spotify instead of Apple Music, Roku instead of Apple TV, Lenovo instead of MacBook, Bose instead of AirPods, Amazon Kindle instead of iPad, and Tile instead of AirTag. The thing is, even with these alternatives, consumers choose Apple 90% of the time. It creates an illusion of choice for the consumer, a tactic that wins nearly every time.

In other words, let’s say you want some Bluetooth earbuds to listen to some music and you just recently bought an iPhone. Apple is saying to you as the consumer:

“Oh, you want some Bluetooth earbuds to listen to some music? You can buy some AirPods for 6 months free of Apple Music if you want. (And just so you know, AirPods automagically connect to your devices when you open up the latch on the case and they switch to any Apple device when you look at it. All hands-free when they’re in your ears by the way.) But hey, you can also get Spotify and Bose earbuds. You just get half the free trial time from Spotify, pay $2 more a month when the trial ends, and to connect your Bose earbuds, go into settings, click three times, and wait around 30 seconds for them to connect everytime you use them.”

Ever wonder why Apple only gives 5GB free cloud storage when Google gives 15GB? Ever wonder why when you buy a new Apple Watch or pair of AirPods you get a half-year free trial for Apple Music and Apple Fitness+? This is again an example of Apple’s ecosystem and their ‘illusion of choice’ in action. You don’t need to buy Apple’s products or services, we live in a free market economy after all, yet every one of Apple’s products are the best-selling in their industry.

Samsung, the main competitor of Apple, doesn’t have this type of ecosystem. In fact, Samsung could never come close to it because Samsung relies on Google for software. Apple controls both the software and the hardware to allow for these seamless abilities between their products. And funnily enough, based on market share, there’s a 53.83% chance you are reading this on an iPhone.

This is Apple’s competitive advantage. This is why Apple controls a ~30% share of the global smartphone market. This, paired with Apple Intelligence, is why Apple is again the world’s most valuable company at the time of writing.

Apple Intelligence and the Apple AI strategy

Finally, AI comes into the picture. According to Forbes, 75% of consumers are worried about the effects of AI, misinformation, and the usage of their data involved with it. Google made the mistake of not doing proper due diligence and perfecting their model to a T before releasing it, which resulted in their model making many mistakes.

Apple doesn’t like making mistakes, and when they release a product or service, they want it to be perfect — they want it to be Apple.

Apple Intelligence is their newest perfection. An AI platform (and ‘Siri 2.0’) integrated into every Apple device seamlessly.

Worried about the usage of your data in AI? All good, Apple Intelligence and ‘Siri 2.0’ run on-device instead of in the cloud where they can see your data. You’re asking too complex of questions to Siri for on-device capabilities? Again, it’s all good, Apple will send your prompt to their cloud, but they’ll keep that data private via Private Cloud Compute. Your data is yours, not ours, says Apple.

Unlike what most believe, Apple Intelligence is not powered by OpenAI. The only instance of OpenAI in the iPhone is if Private Cloud Compute cannot answer your question. In this instance, Siri will ask for your permission to share your data to ChatGPT to answer your query. The liability is off Apple here, but everything else is branded heavily into the privacy of your iPhone. Privacy, privacy, privacy. It’s your data, you have the control.

Apple, the master of branding, strikes again. Apple learned from the mistakes Google made with Gemini, and implemented AI into their customers products with thorough thought.

But there’s a catch-

Apple Intelligence is only available on the iPhone 15 Pro and M1 series devices or later, a group of devices only 5% of Apple users control. Come September, with the release of the iPhone 16 and models supporting these new AI features, Apple is finally making a reason after all these years of stagnation, for existing customers to upgrade their devices. Even if some don’t want to upgrade, one of their friends or family members will, and as they see those friends creating their own emojis and interacting with ‘Siri 2.0,’ it will create FOMO and a want to upgrade anyway.

Revenue and profit growth for Apple in the short term.

In short, Google and OpenAI build the AI, Nvidia supplies the chips needed to power the AI, and Apple takes the built AI for help on problems it can’t solve, globalizes it by putting AI features into all their loyal customers’ devices, but gives the option for customers to not use that built AI if they don’t want to. Even though Google, OpenAI, and Nvidia seem like the best choices here, there’s no market without a consumer, and Apple is manufacturing the AI consumer.

Valuation; Is AAPL 0.00%↑ stock a ‘buy?’

Image: Source

Assuming Apple grows at 11% over the next 5 years, (analyst projections) using a simple DCF analysis with a discount rate of 15%, Apple’s median terminal multiple of 18, and a 25% margin of safety, we can estimate that Apple’s fair value is around $1.4 trillion or $91/share (this is because the growth rate is below the discount rate of 15%, which is the discount rate I hope to obtain from my holdings). (Value Apple yourself using my free DCF spreadsheet and PDF.)

Apple has always been a cash behemoth with immese brand power and powerful marketing. (Not forgetting Apple’s ROIC² of over 55%, FCF³ per share growth of 15%, and 5-year CAGR⁴ of 68%.) I haven’t sold any shares of Apple since buying them back in March of 2023, and don’t plan to. I didn’t buy those shares at $91, but I’ll be holding those shares for years to come.

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Thanks to Moomoo for sponsoring this issue of J. Nicholas. Sign up to Moomoo for some free Apple gift cards by clicking the link below.

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Thanks for reading today’s Deep Dive! I’ll be back in your inbox this Friday for yet another Weekly Brief.

Happy investing, and again, thanks for reading!

☕️ - Jacob xx

1. (per Kantar.)

2. Return on invested capital (ROIC): the amount a business is returning you annually for the dollar amount you’re investing.

3. Free cash flow (FCF): the money left over to shareholders after subtracing a business’s operating income by its capital expenditures.

4. Compound annual growth rate (CAGR): a metric to determine how much a stock’s price has returned every year over a certain period of time. (CAGR can also be used to determine revenue growth, profit growth, etc.)

5. Terms apply. Visit here for more info.