Exploring IBM's Potential in the AI Market Before 2025

Are you in search of an undervalued opportunity in the field of artificial intelligence (AI) as we approach 2025? You might want to consider the technology giant IBM before the chance slips away.

The market has started to view IBM as a significant player in the AI sector. Consequently, IBM's stock has experienced a noteworthy rise, gaining 37% in 2024. This figure increases to 44% if we consider total returns with reinvested dividends.

So, is this tech stalwart still a wise investment following such rapid growth, or is the momentum beginning to fade? Let’s take a closer look at IBM’s current standing and its stock value as we near 2025.

Don’t be misled by surface-level performance

Initially, IBM's most recent financial performance may not seem overly impressive at first glance.

In its latest third-quarter report, sales saw only a 2% increase year over year. This boost was entirely attributed to foreign exchange rates. Earnings per share (EPS) were up 5%, partly due to a slightly reduced tax burden. Does this sound dull to you? It’s a stable report that aligns closely with analyst expectations, but nothing that sparks excitement.

However, a deeper examination reveals that IBM’s seemingly flat results are actually quite notable. The robust infrastructure segment, for instance, experienced a 7% decline in revenue, primarily due to a 19% drop in the cyclical IBM Z mainframe sector. This segment's performance fluctuates according to product cycles, with the next refresh of IBM Z systems scheduled for 2025. This upcoming release promises to introduce enhanced AI capabilities powered by IBM's specialized AI chips.

Offsetting this cyclical downturn, IBM's software and services divisions demonstrated solid performance. Automation revenue climbed 13%, the Red Hat hybrid cloud business grew by 14%, and AI revenues increased by 5%.

You might view that AI growth as underwhelming, considering it should be a primary driver of expansion. It’s indeed reassuring that other business segments managed to compensate for the predictable dip in mainframe sales. But what accounts for the modest growth in AI revenue?

IBM's strategic approach to AI contracts

The reality is that IBM takes a long-term approach to sales. They focus on establishing enduring subscription and technical support contracts. The initial phase can take considerable time, especially when it comes to complex ventures like developing generative AI systems. Potential clients typically navigate through multiple rounds of technical evaluations, managerial endorsements, and financial planning before finalizing agreements.

Once these contracts are signed, however, IBM secures a profitable relationship for the long term.

In spring 2023, IBM unveiled a generative AI platform named watsonx, which has since amassed over $2 billion in firm multiyear contracts within a year.

Just one quarter later, the watsonx order pipeline swelled by another $1 billion. This 50% increase in orders over three months signifies a turning point where Big Blue is poised to convert these agreements into tangible revenue while also initiating more AI-related partnerships.

On the brink of significant advancements after years of preparation

This trend has been evident since the launch of watsonx. This method of operation reflects IBM's longstanding strategy, and now the company appears on the cusp of realizing the benefits of a shift that has been nearly a decade in the making.

Moreover, the upcoming AI-enhanced System Z mainframes will play a pivotal role in a multi-year business cycle. The combination of this driver with the growing AI contract activity is likely to lead to substantial revenue growth and healthy cash flows.

As IBM CEO Arvind Krishna stated in the third-quarter earnings call, "Our portfolio is well positioned to deliver an upward inflection in growth in 2025." This indicates that IBM’s upcoming performance should capture the attention of Wall Street next year.

IBM presents a compelling opportunity in the thriving AI market

The recent stock price increases have naturally uplifted the valuation ratios of IBM. However, in comparison to other AI heavyweights, IBM shares still seem attractively priced, particularly when assessing cash profits. When evaluating the stock on metrics such as price to sales or price to free cash flow, Big Blue is significantly more affordable than counterparts like Nvidia or Microsoft:

AI Stock	Price to Free Cash Flow (TTM)	Price to Sales (TTM)	Market Cap
IBM	16.5	3.3	$207 billion
Nvidia	58.3	29.1	$3.30 trillion
Microsoft	44.7	12.8	$3.2 trillion

Data sourced from Finviz.com on December 20, 2024. TTM = trailing twelve months.

I am truly optimistic about the rising AI sector and do not mind taking a measured approach to investing in this transformative evolution. For this reason, I recommend considering acquiring shares of IBM while they still appear to be reasonably priced. Companies like Nvidia and Microsoft can be considered later.

The anticipated growth in business next year should significantly exceed the modest gains seen in 2024, especially when keeping track of the future-proof watsonx contracts that IBM is securing.

IBM, AI, Investing