Should You Invest in IBM Before 2025?

Are you on the lookout for a promising investment in the artificial intelligence (AI) sector before the arrival of 2025? It's worth considering a leading tech corporation that may be undervalued and poised for growth: International Business Machines (IBM).

After a period of skepticism, the market is starting to recognize IBM as a significant player in the AI landscape. This shift in perception has resulted in a remarkable stock performance, with IBM shares surging by 37% in 2024. If you factor in reinvested dividends, total returns are even higher, reaching 44%.

However, the question remains: is IBM still a wise investment after such impressive gains, or has it reached a plateau? Let’s explore the company's current situation and its stock outlook as we approach 2025.

Looking Beyond the Surface of IBM's Stock

At first glance, IBM's recent financial performance might not seem extraordinary.

In its latest quarterly report, sales experienced a modest increase of 2% year-over-year. This slight uptick in revenue was primarily due to fluctuations in foreign exchange rates. The company's earnings per share (EPS) rose by 5%, partly due to a lower tax rate. This report may appear somewhat lackluster and is generally in line with analyst predictions, but nothing truly exciting stands out.

Upon closer inspection, though, the stability of IBM's results can be seen as a positive factor. Notably, the company's infrastructure segment suffered a 7% dip in revenue, largely attributed to a cyclical drop of 19% in the IBM Z mainframe division. This segment's performance cycles are tied to product launches, and the next refresh of IBM Z systems is set for 2025, which is expected to incorporate enhanced AI capabilities powered by custom AI chips developed by IBM.

Fortunately, IBM's software and services sectors have demonstrated strength, with automation revenues climbing 13%, the Red Hat hybrid cloud business growing by 14%, and AI-related revenues seeing a 5% increase.

It’s understandable to feel that a 5% rise in AI revenues seems underwhelming, given the high expectations surrounding AI as a major growth engine. However, it is reassuring to see other segments compensating for the expected slowdown in mainframe sales. The question remains: why is AI’s growth relatively subdued?

IBM's Strategic Approach to AI Contracts

The key point to understand about IBM is that it does not rely on quick sales. Instead, the company focuses on building long-term subscription and support contracts for its services. The initial phase of this process can be slow, especially with complex technologies like generative AI systems. Many potential clients go through several layers of testing, internal approvals, and budget considerations before they finalize contracts.

Once these clients commit, however, IBM secures reliable revenues for the long term.

In spring 2023, IBM launched its generative AI platform, called watsonx. Fast forward one year, and watsonx has already accumulated over $2 billion in confirmed multiyear contracts.

Just a quarter later, the order backlog for watsonx grew by another $1 billion—a striking 50% increase within a three-month span. This surge signifies a potential tipping point for the company, as IBM converts these contracts into revenue over time while continuing to attract new AI deals.

A Bright Future After Years of Preparation

This operational dynamic has been in play since the introduction of watsonx, which reflects IBM’s long-term strategy that has been developing for nearly a decade.

As we look ahead, the AI-enhanced System Z mainframes expected in 2025 could serve as a significant boost to the company’s revenue streams. The combination of this anticipated business momentum alongside the growing interest in AI contracts should lead to meaningful growth in sales and cash flow.

During the third-quarter earnings call, IBM CEO Arvind Krishna mentioned, "Our portfolio is well positioned to deliver an upward inflection in growth in 2025." This statement hints at the strong potential for IBM's performance to impress investors and analysts alike in the coming year.

IBM: An Attractive Opportunity in the Thriving AI Market

Though IBM has recently experienced some price appreciation, its stock valuation ratios remain appealing when compared to other industry giants. Generally speaking, IBM shares still appear relatively affordable, particularly when assessing free cash flow. For example, whether you're comparing price to sales or price to free cash flow, IBM stands out as a bargain compared to competitors like Nvidia and Microsoft:

AI Stock	Price to Free Cash Flow (TTM)	Price to Sales (TTM)	Market Capitalization
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 Dec. 20, 2024. TTM = trailing 12 months.

I'm enthusiastic about the opportunities that the AI boom presents and am willing to adopt a patient, long-term investment strategy in this transformative sector. Therefore, I highly encourage you to consider acquiring some shares of IBM while they remain affordable. Companies like Nvidia and Microsoft will still be there in the future.

As we move into 2025, IBM's business growth is expected to outpace the more modest gains of 2024, especially as the company continues to capitalize on its future-proof watsonx contracts.

IBM, AI, Investment