IBM — International Business Machines Corporation — (IBM) stock has surged in 2024, outpacing the rest of the market and beating many of its sector peers. Investors appear buoyed by the company’s potential in artificial intelligence (AI), but this “potential” isn’t currently reflected in earnings forecasts. Quantum computing represents another area of great potential, and one where IBM has invested heavily. However, I feel it’s too early to invest in IBM for quantum potential, especially given the stock’s valuation. I’m neutral on this rather expensive stock.
Examining IBM’s Growth Amid AI Excitement
IBM, founded in 1911, is a multinational technology corporation headquartered in Armonk, New York. Its positioning in the information technology segment predates pretty much all of its big tech peers, showcasing decades of leadership in hardware and enterprise solutions.
In light of this history, the company’s stock has risen significantly over the past 12 months—over 70% at the time of writing—largely fueled by excitement around artificial intelligence (AI), as investors have ploughed into stocks with exposure or potential exposure to AI.
However, IBM’s performance had broadly impressed investors until the Q3 results released on October 23. For example, IBM’s recurring revenue, represented by an Annual Recurring Revenue (ARR) of $14.1 billion, grew by 9% year-over-year in Q2, outpacing overall revenue growth of 4%. Meanwhile, the company’s software segment saw an 8% increase in revenue to $6.7 billion, indicating potential for future growth as it becomes a larger part of overall sales.
Moreover, these prospects are compounded by the hybrid cloud market, which is expected to grow significantly, with a compound annual growth rate of 12.4% from 2025 to 2033. Yet, despite these positive indicators, IBM’s stock surge appears more driven by AI hype than by substantial changes in its fundamental business performance.
Is IBM’s AI Hype Overstated?
Personally, I’m concerned that IBM’s exposure to AI might be overstated. While IBM has reported growth in its generative AI business, with a book of business reaching over $2 billion since the launch of watsonx, this figure is small compared to its total trailing twelve-month revenue of $62.36 billion. The company’s AI-related revenues represent a fraction of its overall business.
Moreover, revenue growth certainly isn’t groundbreaking. The 9% ARR year-over-year growth in Q2 was followed by just 1% growth in total revenue in Q3. This suggests that IBM is not yet positioned as a true software-centric company that could justify a higher valuation based solely on AI capabilities.
However, that’s not to say IBM’s AI advancements, including Granite 3.0 and Red Hat OpenShift AI, won’t contribute to future growth, particularly in the consulting business. These technologies enhance IBM’s capability to offer sophisticated AI solutions tailored to enterprise needs. By integrating these advancements into its consulting services, IBM can better support clients’ digital transformation efforts and potentially leverage additional growth.
Will IMB Lead in Quantum Computing?
One area I’m particularly interested in is quantum computing. Quantum computing promises to unlock vast computing potential due to something called superposition — the ability of a quantum system to be in multiple states at one time. In short, it means that vast calculations can be computed in almost no time at all. The problem is, the technology isn’t quite there yet.
In this context, IBM is well-positioned to become a dominant player in the quantum computing industry, having invested billions in research. The company is actively involved in significant quantum research projects, such as the Fermilab-led initiative, which focuses on developing superconducting quantum systems.
Moreover, the global quantum computing market is expected to grow significantly, with projections indicating an increase from $1.21 billion in 2023 to $12.62 billion by 2032, at a compound annual growth rate (CAGR) of 34.8%. This rapid pace of growth presents opportunities for companies that can master the technology and deliver commercially viable solutions.
On the other hand, IBM faces competition from a growing ecosystem of quantum investors, including players like Google (GOOGL) and Microsoft (MSFT). Additionally, smaller companies, such as IonQ, are investing heavily in producing early quantum solutions.
Does this Justify IBM’s Expensive Valuation?
I’m concerned that IBM is expensive relative to its expected growth. The stock currently trades at 22.8x forward earnings, representing a 4.8% discount to the information technology sector as a whole. However, IBM’s expected earnings growth is below the industry average, with a CAGR of just 5.2% compared to the industry average of 14.8%.
Collectively, this results in a price-to-earnings-to-growth (PEG) ratio of 4.43. Even when we account for the forward dividend yield of 2.9%, the stock still appears expensive. As such, IBM seems priced according to unrealized potential, whether in AI or quantum computing. Personally, I think this makes it a risky bet.
Is IBM Stock a Buy, According to Analysts?
On TipRanks, IBM comes in as a Hold based on five Buys, seven Holds, and two Sell ratings assigned by analysts in the past three months. The average IBM stock price target is $227.38, implying an upside potential of 4%.
On paper, IBM doesn’t look like a great value. The company trades above its share price target, and its PEG ratio is quite off-putting, even when dividends are taken into account. There’s, of course, potential in the highly exciting AI and quantum computing segments. However, I’d argue that the price tag is currently too high to take the plunge and invest.
