If any company has dominated the limelight most amid the artificial intelligence (AI) megatrend, it has easily been Nvidia (NVDA). Up a jaw-dropping 2,659% in just the last five years, Nvidia's AI chips have emerged as the preferred choice for so-called hyperscalers like Google (GOOGL), Microsoft (MSFT), and Meta Platforms (META) to power their generative AI platforms - a market touted to reach about $1.3 trillion by 2032. 

However, recently it seems that some cracks have started to emerge in Nvidia's Cinderella story. Concerns over China export controls, overvaluation in the stock, the pace of AI demand, and even the wider U.S. economy all culminated in Nvidia experiencing the worst-ever share price fall in history, erasing a whopping $279 billion off its market cap.

Backed by strong fundamentals and continuous innovation, Nvidia's steady rise is expected to continue, even if at a somewhat decelerated pace. However, the recent volatility in NVDA is a good reminder that investors seeking long-term AI returns would be wise to include some exposure beyond the obvious industry leader.

Fortunately, analysts at Morgan Stanley and Citi recently called out these two alternative AI stocks as their top picks - though one key catalyst seems to be top of mind. Here's a closer look.

Apple Stock

Cupertino-based behemoth Apple (AAPL) has gone far beyond the realm of being a mere tech company. Co-founded by the legendary Steve Jobs and now helmed by Tim Cook, Apple has become a consumer brand synonymous with aspirational devices, and has been a part of our cultural zeitgeist for years. 

With products like its flagship iPhone, Macbooks, Apple Watch, Air Pods, and iMacs in its repertoire, all connected by the ecosystem of its highly profitable Services business, the company is seemingly a giant in whichever area it operates in. This has resulted in AAPL becoming the most valuable company in the world, with a gargantuan market cap of $3.4 trillion.

Up 15.6% on a YTD basis, Apple stock offers a dividend yield of 0.45%, backed by 10 years of consistent growth. Further, with a payout ratio of just 14.89%, Apple can comfortably continue to grow its dividends in the coming years.

Due to the immense popularity of its products and services, Apple has been a revenue and earnings-compounding machine over the years. In the last 10 years, while Apple's revenues have compounded at a rate of 8.03%, earnings have clocked a CAGR of 10.21%.

In the most recent quarter, AAPL beat estimates on both revenue and earnings. During its fiscal Q3, Apple's net sales rose to $85.8 billion, up 4.9% on growth in both Products ($61.6 billion, +1.6% YoY) and Services ($24.2 billion, +14.1% YoY). The company reported record-breaking revenues in two dozen countries, including Germany, Canada, Mexico, and the UK.

EPS rose by 11.1% to $1.40, surpassing Wall Street's expectations and marking the company's sixth consecutive quarterly earnings beat.

Always a cash-rich company, Apple closed the quarter with a healthy cash balance of $25.6 billion, more than double its current debt levels of $12.1 billion.

Apple's launch of new iPhone 16 models has shifted Wall Street's attention to its AI strategy. In addition to the usual selling points, Apple said it will gradually roll out Apple Intelligence to approximately 40% of its iPhone user base by the end of this year, with plans to expand that to over 70% by the end of next year. 

Apple Intelligence will focus on enhancing user experiences through new writing tools and emojis, improving photo capture and editing for reliving memories, offering smarter email and notification summaries for better prioritization, and refining control features with upgraded Siri, improved natural language understanding, and personalized settings. Notably, a recent Morgan Stanley survey revealed that nearly 60% of iPhone owners planning to upgrade in the next 12 months, citing Apple Intelligence as an important factor in their decision.

Prior to the device launch, Apple has been building up its AI prowess quietly over the years. Between 2016 and 2020, Apple was the biggest acquirer of AI startups, scooping up 25 companies in the process. The company also has its own AI Large Language Model (LLM) named Ajax, which has been trained on more than 200 billion parameters. It is also working on a new version of Xcode and other development tools that build in AI for code completion, which would improve the quality of third-party apps on the iPhone.

Citing confidence about Apple's AI capabilities and its muscle to compete with fellow tech giants in the space, Citi analyst Atik Malik named AAPL as his top AI pick. With a $255 price target, Malik said, "It will take time for consumers to test all these new capabilities and really see the impact of how it can improve daily life, before the adoption of AI phones go into the mass consumer market, and we view Apple as in the best position to make it possible given its leading position in the premium smartphone market and seamless integration of software and hardware."

Overall, analysts have an average rating of “Moderate Buy” for AAPL stock, with a mean target price of $246.61. This indicates an upside potential of about 10.8% from current levels. Out of 31 analysts covering the stock, 18 have a “Strong Buy” rating, 4 have a “Moderate Buy” rating, 8 have a “Hold” rating, and 1 has a “Strong Sell” rating.

Arm Holdings Stock

Founded in 1990 as a joint venture between Acorn Computers, Apple, and VLSI Technology, Arm Holdings (ARM) designs semiconductor processors and intellectual property (IP). While the company does not manufacture chips itself, its processor designs are widely licensed by companies across various sectors, including mobile devices, automotive, networking, and IoT (Internet of Things). 

The ARM architecture is known for its energy efficiency, making it the preferred choice for mobile devices, including smartphones and tablets. The company's processors power more than 95% of the world's smartphones, including Apple's iPhone. After a blockbuster IPO about a year ago, Arm now commands a market cap of $145.8 billion, with the stock up a whopping 96.1% on a YTD basis.

In its results for the latest quarter, ARM beat Wall Street's expectations on both revenue and earnings, though investors sold the news on light guidance. In its fiscal Q1, Arm reported total revenues of $939 million, up 39.1% from the previous year, while EPS jumped 67% to $0.40, outpacing the consensus estimate of $0.34. 

Key operating metrics, such as annualized contract value ($1.2 billion, +14% YoY) and remaining performance obligations ($2.2 billion, +29% YoY), increased from the prior year, as well. Liquidity-wise, Arm wrapped up its Q1 with a cash and equivalents balance of about $2.5 billion, much higher than its debt levels of $254 million.

Arm's strong financial performance is driven by the widespread use of its architecture in the smartphone market, and its growing adoption among companies seeking to enhance their AI capabilities. Management has noted that recent increases in royalty revenue stem from customers transitioning from Armv8 to Armv9 for AI applications, such as high-performance computing. Additionally, Arm’s chip shipments have grown at an average of 4% over the past three years, while revenue per shipment has risen by 7%, supported by a prestigious customer base including Google, Microsoft, and Nvidia.

In terms of Arm's application by its customers, Microsoft recently launched its Copilot+ PCs powered by Arm. On Windows 10 and 11, 87% of app usage comes from native Arm versions, excluding gaming. Google also introduced its Axiom Processors, running on Arm-based CPUs for its cloud data centers. Amazon’s (AMZN) Graviton 4 is built on the latest Armv9 architecture for AWS data centers, while Nvidia’s Arm-based Grace Hopper CPU supports generative AI applications. Arm’s revenue per licensee has also grown by an average of 4%, driving its license revenue upward.

Arm continues to capture market share in the chip industry, with its share rising from 39% in 2014 to 51% in 2023, thanks to its cost-effective and energy-efficient chips. For example, the Cortex-A725 CPU delivers 35% better performance efficiency. Arm-based CPU architecture has proven highly energy efficient in AI training, with Google Cloud Axiom showing a 60% improvement in energy efficiency over legacy competitors, and Oracle (ORCL) Cloud’s Ampere Altra Max using 2.8 times less power than traditional alternatives. Arm’s latest Armv9 architecture for smartphones offers 25% better power efficiency than its predecessor, the Cortex-A720, enhancing 3D gaming graphics and improving the energy performance of daily apps.

Finally, the upcoming launch of the iPhone 16 models is expected to significantly benefit Arm. Apple uses Arm's processor IP for designing chips in its products, and Bloomberg estimates sales of around 90 million units for the new models. This will generate licensing fees for Arm, along with royalty payments for each product sold that incorporates Arm’s IP. Morgan Stanley is forecasting upside from Apple Intelligence device upgrades well into fiscal year 2026 for Arm, and named the stock its top AI pick with a price target of $175.

Overall, Wall Street rates Arm stock a “Moderate Buy.” Out of 24 analysts covering the stock, 16 have a “Strong Buy” rating and 8 have a “Hold” rating. ARM trades at a premium to its mean price target of $137.73, while Morgan Stanley's new price target implies expected upside of 18.7%.

On the date of publication, Pathikrit Bose did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.