Broadcom: A Rising Star in AI and Potential Investment Opportunity

Broadcom's Stock Split: Is It An AI Stock To Buy Now?

Broadcom's (AVGO) sky-high stock price is now a thing of the past. The recent split of AVGO stock may have you wondering if it's time to claim your stake in the fast-growing artificial intelligence chip market. To help you answer that question, let's explore the details of Broadcom and its recent stock split. We'll cover the company's position in AI, its financial performance, what analysts are saying and the pros and cons of owning AVGO. I'll conclude with my opinion on Broadcom as a long-term holding. On the heels of the 50-for-1 Chipotle stock split, Broadcom has lowered its per-share price with a 10-for-1 exchange. Prior to the split, AVGO stock was trading for about $1,600 per share. After the split was implemented on July 12, you could buy Broadcom for less than $170. (Shares started trading on a split-adjusted basis on July 15.) Broadcom announced the split in June when it posted earnings for its second fiscal quarter. AVGO stock shares rose about 10% in extended trading that day, according to CNBC. Broadcom designs and sells semiconductor chips and software. The company specializes in application-specific integrated circuits or ASIC chips, which are customized for a specific purpose. The AI boon has been good for Broadcom. According to JPMorgan analyst Harlan Sur, Broadcom owns the second market share position in AI chips after Nvidia (NVDA) and the top share position in ASIC chip designs. Sur estimates the size of the ASIC chip market at $20 billion to $30 billion and growing, with Broadcom owning an estimated 55% to 60% market share. Notably, Broadcom has inked AI ASIC chip deals with both Alphabet (GOOGL) and Meta Platforms (META), two best stocks in their own right. In its latest earnings release, Broadcom reported consensus-beating revenue of $12.49 billion and non-GAAP EPS of $10.96. Revenue growth versus the prior-year quarter was 43% and EPS grew 6%. A primary contributor to Broadcom's quarterly growth was the completion of its VMWare acquisition in November 2023. Excluding VMWare, AVGO's quarter-over-quarter revenue growth was 12.5%. Note that Broadcom's GAAP EPS declined almost 46% in the second fiscal quarter versus the prior year. Amortization of acquisition-related intangible assets, a noncash expense, was the largest factor. The non-GAAP figure also excludes: Today's Broadcom was formed when the company was bought by its rival Avago Technologies Limited in 2016. The transaction, which valued Broadcom at $77 billion, created one of the world's largest semiconductor companies. The combined company kept Broadcom's name and Avago's ticker. Since 2017, AVGO has steadily grown its trailing 12-month (TTM) revenues from about $15 billion to $42 billion. In 2024, AVGO's market cap is $788 billion. Based on AVGO stock price trends, the market responded positively to Broadcom's earnings release, which included the split announcement. Investors also showed their support by pushing up the stock price in the days before the split was implemented. Post-split, the stock rose to close at $169.38 on July 16. Unfortunately, on July 17, Bloomberg broke news that the Biden administration wants to limit China's access to American technology. Less than a month ago, Reuters had reported that Broadcom was designing AI chips for China's ByteDance, the owner of TikTok. The regulatory news shut down any post-split run for AVGO, with the stock closing 7.9% lower versus the previous day. Nvidia, Taiwan Semiconductor (TSM) and ASML Holding N.V. (ASML) were also down -- so it was a tough day for the best AI stocks. The consensus price target on AVGO is $194.13. From a starting price of $156, that implies an upside of 24.4%. TradingView reports 46 analyst recommendations as follows: On June 18, Morningstar reported a fair value estimate for AVGO of $1,550 or $155 adjusted for the stock split. This is slightly below the stock's current price. Analyst William Kerwin, CFA, says Broadcom has a significant opportunity in AI chips, but he believes the stock price already reflects that upside. The main benefit of investing in Broadcom is the exposure to the AI chip market within a somewhat diversified revenue model. Broadcom also owns software company VMWare, which supports enterprises that are building and developing in private cloud environments. Additionally, the company makes products for server storage and enterprise networking. In Broadcom's second-quarter earnings release, President and CEO Hock Tan noted rising demand in AI as well as strength in VMWare. But that isn't the full story. Broadcom's legacy business also showed improvement. According to Hur, Broadcom's bookings outside of AI and VMWare have been up double digits for two consecutive quarters. The takeaway? Relative to Nvidia, the other dominant AI chip designer, Broadcom is less reliant on continued high demand for AI hardware. The stock split doesn't change that dynamic. The main benefit of the split is the lower AVGO share price so that it is easier to fit into your investing budget. Two primary risks to consider before investing in AVGO are its valuation and the potential for near-term volatility in AI chip demand. From a valuation perspective, AVGO's trailing P/E ratio is 67.2, which is very similar to NVDA's trailing P/E of 69.04. AVGO's forward P/E and PEG ratios are slightly more reasonable at 25.97 and 1.15, respectively. NVDA's forward P/E is 45.05 and its PEG is 1.34. Neither stock is a bargain, but AVGO may be a slightly better deal. Broadcom's position in the AI chip market can be a boon or a bust for shareholders. Researchers generally predict continued strong demand for AI-capable chips at least through 2030. But there's always the chance for short-term pullbacks related to supply chain issues, economic recession or regulatory changes that affect the business case for AI development. Those situations are likely to be temporary, but AVGO's stock could take a hit as a result. This near-term volatility is not necessarily a deal breaker for owning AVGO, however. Take it as a reminder to be strategic about how much you invest and what your diversification strategy is. Analysts expect AVGO to deliver 13% GAAP EPS growth this year and 26.8% growth next year. The average annual EPS growth expectation for the next five years is 17.8%, as reported by Yahoo Finance. For investors who don't own Nvidia, Broadcom is a long-term buy. The company's dominant position in the growing AI ASIC chip market is attractive. And it looks even better when you consider the revenue diversification from AVGO's cloud software business VMWare.

Broadcom Stock Could Be The Best AI Pick Among Large-Caps (NASDAQ:AVGO)

I initiated coverage of Broadcom Inc. (NASDAQ:AVGO)(NEOE:AVGO:CA) stock about a year ago with a "Hold" rating, which I upgraded to "Buy" in April 2024, admitting my mistake. Since my upgrade, the stock has continued to rise, gaining nearly 21% to date and outperforming the S&P 500 Index (SP500) (SPY) by more than three times: In my last article on AVGO, I argued that the stock was actually looking quite cheap despite its seemingly high valuation multiples on a TTM basis. At the time, I tried to model out the company's future using a DCF valuation method, which showed a great undervaluation of around 25% - and therefore upside potential. However, with the stock up almost 21%, I decided to look at AVGO again and do the same analysis as last time. Based on the latest data (Q2 FY2024 financials and recent news), I again conclude that the price target for AVGO should be higher - the stock is still undervalued, so today I reiterate my previous "Buy" rating. Let's take a quick look at AVGO's latest financial results for Q2 FY2024. I know it's been a while since the results, and they've probably already been reflected in the stock price, but in my last update I didn't have the Q2 data yet, so I feel it's necessary to discuss it here. Actually, Broadcom reported stunning Q2 2024 revenue growth of $12.49 billion, up 43% YoY and 4% quarter-over-quarter, beating the consensus estimate of $12.01 billion (this was the biggest quarterly surprise over the past few years, according to Seeking Alpha data). Speaking of particular segments, Broadcom's AI revenue increased to $3.1 billion, up 280% compared to Q1 2024 results ($2.3 billion). We saw that strong bookings at VMware contributed to this significant increase, potentially suggesting higher revenues for the remainder of FY2024. Infrastructure software revenue amounted to US $5.3 billion, up 175% year-on-year and 16% quarter-on-quarter, mainly due to VMware contributing $2.7 billion in all three months; excluding VMware, infrastructure software revenue was US $2.6 billion, up +35% YoY and +5% QoQ, so the growth is not just all about VMware's impact. Semiconductor Solutions accounted for $7.20 billion, up +6% YoY and -3% QoQ. The company increased sales of AI solutions such as Ethernet products and AI accelerators by more than 40%, while generative AI solutions, among others, accounted for more than half of total sales in this category. However, other business lines showed mixed results in different areas within the business lines Networking contributed almost half (45%) more to sales in the previous year and a further +15% in the previous quarter, mainly due to "the accelerated rollout of high- speed networks and increased hardware sales." Wireless revenue of $1.6 billion increased only by 2% YoY (-9% QoQ), pointing to the stability of Broadcom's wireless outlook, underlined by its multi-year pact with Apple (AAPL) for 5G RF components. In contrast, Storage Connectivity revenue fell -25% year-over-year and -7% quarter-over-quarter due to "carrier and enterprise destocking", despite initial expectations of an uptick in this area. Finally, broadband revenues fell by more than 1/3 year-on-year and by 22% QoQ due to "low capital expenditure by service providers", which is expected to lead to a very large annual decline of 30%. The consolidated adjusted EBITDA amounted to almost $7.5 billion - that's a margin of 59% relative to sales. Around 72% of that EBITDA settled down in the bottom line, so despite the share outstanding amount rising by >12% YoY in Q2, AVGO's non-GAAP EPS share were $10.96, up 6% YoY (slightly lower than the prior quarter though). It was more than enough to beat the consensus on this front either. As the management reiterated its previous guidance for wireless revenue to be essentially flat year-on-year in FY2024, and probably looking at the QoQ declines across some segments, Wall Street analysts were ambivalent about changes to their EPS and sales projections for the next few quarters; despite the strong Q2 figures, only 68% of all estimates revisions were positive. However, in fairness, it's worth noting that the revisions trend in the longer term looks very bullish: I usually take EPS revisions as strong as AVGO's as a very positive sign, as they show me that the market continues to have confidence in the company, and this confidence is likely to justify a premium to its valuation from now on. However, these positive revisions must be supported by real fundamental growth and expansion opportunities (desirably both in sales and margins). I think this is exactly the case here. I believe AVGo's AI-driven growth should help it mitigate cyclical weaknesses in the broadband and memory businesses. The CEO said they anticipate that generative AI will account for at least 37% of semiconductor revenue in FY2024, and if that's the case indeed, the cyclicality will become a less major risk factor in the future, in my view. Broadcom has raised its annual revenue guidance to over $51 billion and expects growth of >40%, with a significant portion coming from software, potentially improving the company's margin profile. The diversified customer base and high recurring revenues from multi-year contracts position Broadcom for sustainable growth and market share gains. Just a few hours ago, the news broke that AVGO is in talks with OpenAI to develop new AI chips - thus the company's reach continues to grow, making my assumption that AVGO's sales will grow organically without being as dependent on the economic cycle as before closer to reality. With all this in mind, I intend to update my DCF model based on my new estimates. Currently, the Wall Street analysts' forecasts are for AVGO sales growth of ~13.04% over the next 5 years. But given the acceleration in revenue growth in recent quarters, I think the actual CAGR could be even higher - adding 1-2% to each of the forecast years, I expect the implied revenue CAGR for the next 5 years to be ~14.3%. Due to the lower dependence on cyclicality and the potential expansion of the EBIT margin through a gentle change in the sales structure, I think that AVGO has every chance of achieving a long-term EBIT margin of ~63%. Based on the historical averages for the ratio of D&A to sales, CAPEX to sales, and NWC to sales, I get the following outputs: Assuming 5% in cost of debt, 5% in MRP, and a risk-free interest rate of just over 4%, I obtain a WACC of 9.7%. This rate is 0.4% below what I expected 3 months ago, but it's worth remembering that expectations for the Fed's policy reversal have also risen in that time. I use an exit multiple method to calculate the terminal value - in this case, I use an EV/FCF multiple of 25x. Why 25x? Again, my decision was influenced by the assumption that AVGO's operating performance would be more stable than we had previously seen. Therefore, the premium to the current valuation should remain at a reasonable level. Compared to the TTM EV/FCF multiple of 45x, my assumption seems quite conservative; on the other hand, I give AVGO a premium relative to its 5-10-year median. So what do I get? According to my updated valuation model, which is admittedly more optimistic than before, AVGO stock looks even more undervalued than 3 months ago - it's undervalued by 38.6%: From all this, I conclude that AVGO can still be a good investment in the medium term. Furthermore, AVGO could be the best AI growth stock pick among large-cap companies today due to its potential upside. As I noted in my previous article, all prospective buyers of AVGO stock should keep in mind that investing in Broadcom, like anything else on the stock market, comes with risks. It's essential for investors to consider the company's recent acquisition spree, which has significantly increased the company's debt load. However, I'd like to immediately note here that thanks to the strong FCF that the company generates (FCF margin = 33% of sales), its debt-to-equity is still well below 1, and it keeps falling lower: Although AVGO's debt seems to be manageable, if the company fails to sustain its growth momentum over an extended period, the burden of debt could negatively impact its financial performance and, subsequently, its stock price. Another risk factor to consider is the fair valuation of Broadcom stock. There's a possibility that I'm leaning towards too optimistic scenarios regarding future margin growth, which is a key element of my DCF calculations. If the company's EBIT doesn't reach the level I expect over the next 5 years, the validity of my forecasts could be called into question. Although I apply a significant discount to the free cash flows (at 9.7%), I use a relatively high exit EV/FCF multiple [25x] to calculate the terminal value. If this assumption doesn't hold - say AVGO's EV/FCF will be 18x in FY 2028 instead of 25x - this could indicate that Broadcom's current stock price is reasonably valued, suggesting limited growth potential based on fundamental value analysis. I am also puzzled by the high probability of consolidation of AVGO stock, at least in the next few months. The point is that AVGO may need more time to grow further after its phenomenal rally in recent years. Therefore, I'd recommend everyone to be cautious; you may even consider buying AVGO not based on current prices, but waiting for a decent dip. Despite the above-mentioned risk factors, as well as some segments' weaknesses in Q1, I believe that AVGO's diversified customer base and high recurring revenues from multi-year contracts position the company for sustainable growth in the coming years, making AVGO's revenues less cyclical and the consolidated margin higher by historical standards due to the shift to higher margin revenue segments. Based on my revised DCF valuation model, AVGO stock now appears to be even more undervalued compared to three months ago, showing a 38.6% undervaluation. That's why I confirm my "Buy" rating today, calling AVGO probably the best AI-related stock pick among large-caps.

Broadcom: An AI-Flavored Dividend Growth Stock (NASDAQ:AVGO)

Broadcom Inc. (NASDAQ:AVGO) just completed its 10-for-1 stock split which makes the dividend growth stock much more compelling for investors that were previously repelled by Broadcom's $1,000+ price. With the stock split being completed and Broadcom driving robust sales growth, particularly in infrastructure software, I think the risk/reward relationship remains compelling. Broadcom profits from heavy spending in the semiconductor and data center industries which has already led to substantial sales and profit tailwinds for the semiconductor and networking company in the last quarter. With an earnings multiple of 26x, Broadcom's stock is cheap enough for a buy stock classification, in my view. Broadcom supplies the necessary switching and routing infrastructure needed for its enterprise customers and hyperscale data centers to participate in the artificial intelligence revolution. Broadcom is a major infrastructure player and provides key equipment solutions, including in the software market. With a market valuation of roughly $744 billion, Broadcom is one of the biggest infrastructure companies in the sector. The semiconductor and networking company looks back on an impressive 2Q24 which ended on May 5, 2024. Robust demand for Broadcom's semiconductor and infrastructure software products led to 43% YoY sales growth and total net sales of $12.5 billion. Infrastructure software has been doing really well for Broadcom in the last quarter, with the segment enjoying a 175% YoY sales uplift, thanks to strong demand for VMware's software stack that enterprise clients use to build their own cloud solutions. VMware is a cloud computing virtualization platform that helps companies run applications leveraging the strength of a cloud environment. VMware was acquired by Broadcom in 4Q23 in a stock-and-cash transaction valued at $69 billion. It was primarily the momentum of VMware's software stack that caused Broadcom to raise its guidance for 2024 sales. Goldman Sachs' research note indicated, however, that there are risks to this kind of spending as companies need productivity gains in order to justify this elevated level of AI spend. MIT professor Daron Acemoglu, for example, suggested that AI will only boost productivity by 0.5% per annum moving forward and have a limited impact on GDP growth. For now, however, the outlook for Broadcom looks healthy and the company raised its sales outlook from $50 billion (March forecast) to $51 billion in June. Sales growth does not exclusively come from the infrastructure software segment, obviously. AI is driving growth in Broadcom's other segment, semiconductors, as well: Broadcom anticipates it will produce more than $10 billion in sales this year (35% of total semiconductor solutions sales) directly related to AI. Incremental demand for Broadcom's semiconductor solutions as well as software has created expansion potential for the company's gross margins (gross profits as a % of net sales). Broadcom enjoyed a gross margin uplift of 3,700 basis points to 74.7% in 2023, with 2019 being the base year for comparison. Sizzling demand for AI hardware and software products should lead to incremental margin upside for Broadcom in 2024 as well. Broadcom's stock has been a strong performer this year, up 44% so far in 2024, but the recent 10-for-1 stock split and the potential for sustained dividend growth (see next section) is the reason why I still see a desirable risk/reward relationship. The market presently models 27% YoY growth and profits of $6.05 per share for Broadcom next year. This year, profits are estimated to go up a more moderate 13%. Post-split, AVGO is selling for 26.2x leading (next year's) profits. NVIDIA Corporation (NVDA), the leading beneficiary in the AI hardware market and investor darling given its impressive GPU lineup, is anticipated to see 37% YoY growth and investors price the stock at 32.3x next year's estimated profits. Does this mean AVGO is an absolute steal? No, obviously not. Broadcom is only a tad cheaper than Nvidia, and Nvidia has much more impressive sales and profit momentum, a key reason why I just called Nvidia a gift even at $130. With that said, though, Broadcom's infrastructure equipment, VMware momentum, and long-term secular demand drivers for data centers imply a favorable demand context that could reasonably be expected to equate to sustained sales and profit growth. At the very least, I anticipate Broadcom to trade up to 30.0x earnings multiple (implied value of $190) in the long run, primarily because of the factors that I just argued support the investment thesis. What makes Broadcom a kind of unique AI-themed investment is that opposed to other companies, Broadcom has a shareholder-friendly distribution policy in place and has grown its dividend by leaps and bounds in the last couple of years. Most recently, AVGO paid a $5.25 per share per quarter dividend which equates to a yield of 1.2%. Because of the ten-for-one stock split, the dividend amounts will reset lower, but the yield, of course, will remain the same. Broadcom has been a solid dividend grower in the last year which is the main reason why I am including AVGO in my dividend growth portfolio. Companies are trying to set themselves up for the age of artificial intelligence, thereby sending AI spending through the roof and creating demand surges for the kind of products that Broadcom is offering its customers. Broadcom, as a critical equipment supplier, appears poised to profit from these tailwinds. However, there is clearly a risk that the market overestimates the benefits of the AI spending ramp which may at some point lead to more moderate sales and profit growth for Broadcom. Of course, this would pose a risk of multiple compression. Broadcom is poised to perform well in the short term as the outlook for the AI/data center industries is highly favorable. Equipment companies like Broadcom are delivering critical infrastructure which has led to a jump in the company's net sales in the last quarter. Companies have been ramping up their spending on processors, GPUs, AI servers, chip designs, and data centers which is poised to benefit Broadcom moving forward. What is unique about Broadcom is that an investment in AVGO merges the AI theme with substantial dividend growth. Most AI stocks don't pay a dividend at all. With Broadcom being exposed to substantial AI tailwinds and paying a growing dividend, I think that AVGO has a unique role to play in a passive income investors' portfolio.

Apple Stock Is More Expensive Than Nvidia (NASDAQ:AAPL)

Last month, Apple (NASDAQ:AAPL)(NEOE:AAPL:CA) officially entered the AI race with the introduction of Apple Intelligence. Since then, several new pieces of information have come out relating to Apple's AI strategy, although various unknowns still remain. Nonetheless, the onset of Apple Intelligence has sparked an astounding rally in the share price, with investors assigning a stock valuation as if the company is set to dominate the era of AI, a crown that currently belongs to Nvidia. In the previous article on Apple, we discussed Apple's growth opportunities in the enterprise space amid the AI revolution. We discussed how Apple already has a competitive advantage in designing its own chips for years, on which it had already been running Machine Learning/ Artificial Intelligence workloads for years, paving the way towards building silicon to support generative AI workloads now. We also discussed opportunities on the enterprise software side for Apple. Now in this article, let's cover Apple's revenue and profit growth prospects through the Apple Intelligence platform. We delve into the bull case, and then compare the stock's valuation to AI leader Nvidia and other Magnificent 7 stocks. A 'hold' rating has been maintained on Apple stock. Apple Intelligence is essentially Apple's own AI platform, constituting of on-device processing and private server processing in the company's own data centers. Wall Street analysts have turned very optimistic on the company's growth opportunities following the revelations of new generative AI capabilities on its hardware devices, as part of the iOS 18 rollout later this year. Recent research from Morgan Stanley revealed that: Our deep-dive analysis into Apple's upgradeable iPhone base, upgrade rates, new user growth and iPhone model mix suggests that Apple will ship nearly 500M iPhones over the next two years, 6% higher than the record FY21-FY22 cycle, while also driving 5% annual iPhone ASP growth, resulting in nearly $485B of total revenue and $8.70 of earnings power by FY26, 7-9% above consensus ... The bank expects Apple to ship 235M iPhones in fiscal 2025 and 262M in fiscal 2026. Note the investment bank cited both "upgrade rates" and "new user growth" as catalysts for iPhone sales growth. In terms of upgrade activity expectations, Wedbush Securities research pointed out that: 270 million, of 1.5 billion iPhones, have not upgraded in 4+ years That comes out at 18% of the iPhone installed base which are due for an upgrade. Now whether Apple will be able to persuade the rest of the user base to upgrade in order to access Apple Intelligence, or even attract new consumers into the ecosystem, will highly depend on how well Apple actually executes on this AI vision presented at the 2024 Apple Worldwide Developers Conference. Apple will need to prove that Apple Intelligence, running on its in-house models, GPUs and servers, can match up in performance against Google and Microsoft's generative AI-powered software services/ assistants, namely Gemini and Copilot, respectively. The fact that Apple has built and trained its own generative AI models to power the new Siri, along with the other generative AI features, is certainly a very encouraging sign. Now these are much smaller models that can run on-device to complete various day-to-day generative AI-powered tasks. Apple revealed that its on-device model is 3 billion parameters in size. The tech giant also runs a larger language model on its private servers in its own data centers, to which workloads are sent for tasks that cannot be processed by the iPhone's silicon. Apple has not disclosed how many parameters constitute this model, but likely to be much smaller than the current publicly available Large Language Models (LLMs). For context, OpenAI's GPT-4 model is estimated to have almost 1.8 trillion parameters. Industry observers believe that the larger the model, the greater its capabilities. Though smaller language models should indeed suffice for personal use-cases among smartphone users. While the demos at WWDC were intriguing, Apple will now need to prove to both customers and investors that the models it has designed in-house can seamlessly and effectively execute all sorts of tasks prompted by its users. Nonetheless, Apple building its own models positions the company better than rival Microsoft, which is still outsourcing its models from OpenAI to power the Copilot+ PCs introduced earlier this year. From this perspective, Google is a more viable competitor, with its powerful, multimodal Gemini model powering its suite of new AI services, augmenting the value proposition of its Android operating system for smartphones. Nonetheless, Apple remains better positioned than both these tech rivals, given that out of the three, it offers the most well-established suite of personal computing devices, including smartphones, laptops/ desktops, and even smartwatches. But perhaps Apple's biggest advantage is that it controls the entire technology stack, down from the silicon to the hardware device itself, to the operating system, and all the way up to the consumer-facing software applications like iMessage. This unmatched vertical integration yields incredible performance advantages for Apple devices. Now Apple is striving to prove that this deep integration across multiple layers can also yield better AI inferencing performance, such as in the form of lower latency to provide faster responses to user prompts. Apple's unique vertical integration certainly gives it a leg-up over its key rivals. At the hardware level, Apple will undoubtedly charge a premium for its next-generation iPhones and Macs with the debut of Apple Intelligence, supporting Average Selling Price [ASP] growth. As per the citation earlier in the article, Morgan Stanley expects "5% annual iPhone ASP growth". Though aside from higher price points driving revenue growth, Apple's ASP could also benefit from higher compute processing needs on devices. Moreover, Apple's new generative AI-powered Siri and other features like "Genmoji" will require a lot more computing power than the traditional prompts until now. To process these increasingly compute-demanding prompts and queries, Apple will be rolling out new generations of its silicon, which will be monetized through higher retail prices for its devices. But additionally, these complex queries will also require much higher on-device memory (both short-term and long-term memory). To understand this additional revenue opportunity, remember that hardware devices come with two forms of memory, Random-Access Memory [RAM] and Storage memory. RAM memory is used for temporary processing of everyday tasks, mainly running and loading apps. It is a form of short-term memory. For example, asking Siri about the weather forecast or using the calculator app on an iPhone would use RAM memory. The more RAM memory a device has built in, the faster the processing of such tasks will be. iPhone 15 Pro and iPhone 15 Pro Max reportedly have 8GB of RAM. And then there is the long-term storage memory, which is the memory used for storing data, files, music, photos, etc. All iPhone base models come with 128GB memory, with availability to upgrade to 256GB and 512GB models. Apple charges $100 extra for every additional 128GB in storage memory. While the RAM memory on iPhones cannot be upgraded, it can be upgraded for MacBooks. Base models for MacBooks come with 8GB memory, with upgrade possibilities to 16GB and 24GB. Apple charges around $200 for every 8GB of additional memory. Processing complex generative AI workloads will require higher RAM memory, giving Apple the opportunity to sell base models with higher RAM memory built-in. At the WWDC, Apple also emphasized the importance of data privacy in the era of Apple Intelligence, and highlighted that: When you make a request, Apple Intelligence analyzes whether it can be processed on-device. If it needs greater computational capacity, it can draw on Private Cloud Compute, and send only the data that's relevant to your task to be processed on Apple silicon servers. Your data is never stored or made accessible to Apple. It's used exclusively to fulfill your request. So in other words, Apple does not store user data on its servers, all data will be stored on-device. So as the new, more advanced Siri assists users with more complex personal queries, more long-term memory storage may be required on devices so that Siri can store data about the user's personal preferences and recall that data the next time the user makes similar requests. (Though greater use of iCloud storage subscription services by users could counteract the need for higher storage memory on devices). Nonetheless, the overarching point is, growing utilization of generative AI-powered software applications and the new Siri should increase memory requirements on-devices (particularly RAM). Hence, Apple could potentially introduce base models with higher memory capacity built-in to facilitate a more seamless and richer experience for Apple Intelligence, enabling the tech giant to charge an additional hundred dollars or more per device sold, boosting top-line and bottom-line growth for investors. Now moving onto Siri, as per Apple's announcements at WWDC, the new generative AI-powered Siri and various other features will be available for free to all Apple device users as part of iOS 18. Though, additional monetization opportunities could arise as Apple's product roadmap evolves. Let's consider how other tech giants are planning to monetize similar generative AI-powered services. Google allows people to use the Gemini chatbot for free to a certain extent, and ultimately encourages them to upgrade to Gemini Advanced for a subscription fee, to access larger models and complete more complex tasks. There have also been reports of Amazon planning to charge a monthly subscription fee for a new generative AI-powered Alexa voice assistant. And on Meta Platforms' last earnings call, CEO Mark Zuckerberg also suggested charging users for access to larger AI models, while the current Meta AI assistant remains free. Indeed, processing these increasingly complex queries in the era of generative AI is resulting in higher computing costs, and other tech giants are seeking to pass on these costs to consumers through monthly subscription fees. As Apple's Siri becomes increasingly advanced and develops more agentic capabilities to complete more complex, multi-step tasks at once, Apple may eventually have to charge monthly subscription fees for this feature as well, given that it may not be able to continue absorbing the costs of processing on its private cloud servers. Alternatively, instead of processing tasks on servers, Apple could build increasingly powerful chips for its devices to facilitate more on-device processing, and monetize more versatile Siri capabilities up-front by raising prices for its hardware like iPhones and Macs. Furthermore, perhaps one of the most anticipated announcements at WWDC was the partnership with OpenAI, with ChatGPT becoming accessible through Siri to answer questions about "broad world knowledge" or "specialized domain expertise". Bloomberg reported that Apple is not having to pay OpenAI for the integrated service. Apple benefits from being able to provide more extensive AI capabilities to its users, while OpenAI gains accessibility to Apple's massive installed base. Going forward, Apple will likely strike deals with other model providers like Google and Anthropic to give consumers more choice. Now investors are trying to foresee Apple's monetization opportunities here. Currently, the primary monetization approach of these third-party model providers is to give away the simple version of their chatbots for free, while charging a subscription fee for their more advanced models. Certain market participants are expecting Apple to potentially earn a share of revenue if these third-party model providers gain subscribers through the Apple ecosystem. Though uncertainties still remain around, Apple's exact monetization strategies here. While the new generative AI-powered features introduced by Apple and other tech giants are highly expected to encourage consumers to upgrade, Apple has said that the features may not be perfect and could make mistakes. There is a risk that consumers wait to upgrade, relying on product reviews and experiences from other users, before they decide to buy. This could lead to an underwhelming upgrade cycle relative to Wall Street's expectations. Take Microsoft's Copilot rollout as an example. While initially enterprise customers were very excited to deploy Copilot within their organizations based on the demo videos, adoption of the generative AI-powered assistant (costing $30 per user/ per month) following official launch has been slow, with reports of Copilot making various mistakes when used for a range of organizational tasks. It is worth noting that Microsoft has also cautioned users that Copilot on its new Copilot+ PCs, which compete directly against Apple's AI-powered Macs, could make mistakes, given the nascency of this technology. Now in the case of Apple, it is already embarking on a bolder strategy relative to most other tech giants, by relying solely on in-house silicon, servers and operating systems to facilitate generative AI-powered services, while competitors are heavily relying on Nvidia's technology. Apple will need to prove that the iPhone 16, iOS 18 and Apple Intelligence will live up to the hype in terms of performance. While publicly available chatbot services and AI models have been frequently tested and compared to determine performance strengths and weaknesses, the efficacy of Apple's in-house models and generative AI-powered services can only be determined upon the launch of Apple Intelligence later this year. Any hint of glitches or underwhelming user experiences could discourage users from upgrading and wait for future generations until the AI technology is perfected. New smartphone buyers could even opt for Android devices, if Gemini is able to facilitate richer AI experiences than Apple's AI models. Or even if the performances of these models match up to each other, Android devices offer lower price entry points for consumers to experience AI, giving it an edge to attract customers into the Google ecosystem. Moreover, while the WWDC boasted a broad range of generative AI capabilities, not all features may be immediately available. For instance, cross-app task completion capabilities with Siri may not be available until 2025. Hence, we may only gain clearer visibility of iPhone sales prospects once Apple reveals which features will be available as part of iOS 18. Despite the uncertainties and risks around the next upgrade cycle, AAPL stock seems to be priced for perfection at 35x forward earnings, leaving little room for error. This heightens the risk of a major stock price connection. Apple's revenue growth had been in decline for over a year, contracting by 4% last quarter, led by hardware sales falling by 10%. Following the launch of Apple Intelligence, the market is now optimistic that this will reverse the revenue trend, as consumers are enticed to upgrade to devices fit for the AI era. Apple's full control over its entire technology stack, from the GPU up to the software applications, allows investors to be confident that the Cupertino-based giant will be able to deliver industry-leading consumer AI experiences. Silicon advancements to enable greater on-device computing and augment the user experiences could yield stronger pricing power, driving revenue and profit growth for shareholders. And as discussed earlier, facilitating more complex computations to run generative AI workloads will extend the need for more memory capacity on devices, further supporting Apple's ASP growth, conducive to a rebound in revenue growth. Now in terms of profitability, Apple's net margin has remained relatively steady around 25% over the past several years. The expected ASP growth for its hardware devices amid the generative AI wave will be accretive to Apple's profit margins. Although the higher costs of computing through Apple's Private Cloud, when users' more complex queries can not be processed on-device, could undermine net margin expansion potential. Nonetheless, unlike other major tech giants that are spending heavily on building out data centers using Nvidia's AI computing solutions, Apple has not signaled plans to significantly step up CapEx to support the company's AI ambitions, suggesting that CapEx will stay in the usual range of $10 billion to $11 billion annually. In fact, when asked by an analyst on Apple's FY2024 Q2 earnings call, CEO Tim Cook said: We have our own data center capacity and then we use capacity from third parties. It's a model that has worked well for us historically and we plan to continue along the same lines going forward. Apple's lighter approach to data center buildouts should also support net margins for the foreseeable future. Apple is likely to allocate more of its CapEx spending on designing increasingly more powerful chips to facilitate more on-device processing, thereby reducing the need to send queries to private servers. This would certainly be a much wiser approach, as it would yield more superior inferencing performance that augments users' experiences, and bolsters Apple's ability charge higher prices for its suite of hardware devices. That being said, there are indeed risks that could manifest in an underwhelming upgrade cycle. As discussed earlier, Apple will need to prove that its in-house generative AI models are competitive against the popular models currently out there. Users waiting to see if the upgrade is worth it, and/or Apple Intelligence not living up to expectations among the beta testers, or competitors like Google potentially offering better AI experiences, could all result in slower top-line and bottom-line growth for Apple. Though these uncertainties have not stopped investors from pushing Apple stock's valuation higher. Apple currently trades at a forward PE multiple of around 35x, significantly higher than its 5-year average of almost 27x. Furthermore, Apple's expected EPS FWD Long Term Growth (3-5Y CAGR) of 10.39% is rather underwhelming relative to how the stock is currently valued. Adjusting the forward PE by this anticipated EPS growth gives us a forward Price-Earnings-Growth [PEG] ratio of 3.33, much higher than its 5-year average of 2.38, and making it one of the most expensive stocks out of the Magnificent 7. For context, a forward PEG ratio of 1 would imply the stock is trading at fair value, though popular tech stocks traditionally trade at a premium valuation of between 1.5 to 2. Excluding Tesla, Apple would be the most expensive Magnificent 7 stock. In fact, it is even more expensive than Nvidia, the crowned king of the AI revolution. The fact that the Cupertino-based giant is not reliant on Nvidia's expensive GPUs and hardware, like rivals Google and Microsoft are, and that Apple will be running generative AI workloads on purposely built on-device chips, in-house private cloud servers, and in-house operating systems, has certainly impressed Wall Street, signaling that is in better control of its AI future than initially perceived. Boasting an installed base of over 2 billion devices, Apple is a force to be reckoned with in the consumer AI space. And with a notable proportion of consumer AI running on its own operating systems across iPhones, Macs, iPads, smartwatches as well as private cloud servers, the market has rewarded AAPL with a lofty valuation. Although Apple stock is currently valued as if it is the king of AI, Nvidia. The market may be getting ahead of itself by rewarding AAPL with a higher valuation than Nvidia. In a recent article, we delved deeply into Nvidia's monetization opportunities for NVIDIA AI Enterprise, the core operating system powering AI software applications, with Nvidia earning $4,500 per GPU/ per year, and locking customers into the ecosystem to induce frequent upgrades to the next generations of its chips. Contrarily, Apple has yet to show investors how it can convert its full control of its AI infrastructure into recurring hardware and software revenue. Convincing end-consumer to upgrade their iPhones regularly for AI updates could be more difficult than Nvidia convincing enterprises to purchase increasingly powerful AI chips on a frequent basis to stay competitive. For context, Nvidia's expected EPS FWD Long Term Growth (3-5Y CAGR) is 33.48% Hence, while Apple's AI growth story is certainly a bullish one, it is hard to make the case for buying the stock when it is trading at a lofty forward PEG ratio of 3.33, while the most sought-after Magnificent 7 stock, Nvidia, trades much closer to fair value at 1.29. This does not necessarily mean that AAPL has to trade at a cheaper valuation multiple than NVDA to make it a stock worth buying, but a forward PEG closer to (or preferably below) its 5-year average of around 2.30 would make it a more reasonable valuation.