IBM (International Business Machines Corporation) (IBM) shares have soared in 2024, outperforming the rest of the market and beating many peers. Investors seem buoyed by the company’s potential in artificial intelligence (AI), but this ‘potential’ is not currently reflected in earnings forecasts. Quantum computing represents another area with great potential, and one in which IBM has invested heavily. However, I think it’s too early to invest in IBM for its quantum potential, especially given the stock’s valuation. I am neutral on this rather expensive stock.
Founded in 1911, IBM is a multinational technology company headquartered in Armonk, New York. Its positioning in the information technology segment predates virtually all of its major tech peers, and reflects decades of leadership in hardware and business solutions.
In light of this history, the company’s shares have risen significantly over the past twelve months (over 70% at the time of writing), largely fueled by the excitement around artificial intelligence (AI), as investors piled into stocks with exposure or potential exposure to AI.
However, IBM’s performance had impressed investors until its third-quarter results were released on October 23. For example, IBM’s recurring revenue, represented by annual recurring revenue (ARR) of $14.1 billion, grew 9% year over year in the second quarter, surpassing IBM’s growth rates. total turnover 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 share of total revenue.
Furthermore, these prospects are further exacerbated by the hybrid cloud market, which is expected to grow significantly, with a compound annual growth rate of 12.4% between 2025 and 2033. Yet, despite these positive indicators, IBM’s share price rise appears to be more are caused by AI hype than by substantial changes in fundamental business performance.
Personally, I worry that IBM’s exposure to AI is being overstated. While IBM has reported growth in its generative AI business, with revenues of over $2 billion since the launch of Watsonx, this figure is small compared to total twelve-month revenues of $62.36 billion. The company’s AI-related revenues represent a fraction of its total revenue.
Moreover, the turnover growth is certainly not groundbreaking. The 9% year-on-year growth in the second quarter was followed by just 1% growth in total revenue in the third quarter. This suggests that IBM is not yet positioned as a truly software-focused company that could justify a higher valuation based solely on AI capabilities.
However, that doesn’t mean that IBM’s AI developments, including Granite 3.0 and Red Hat OpenShift AI, won’t contribute to future growth, especially in the consulting industry. These technologies enhance IBM’s ability to deliver advanced AI solutions tailored to enterprise needs. By integrating these developments into its consulting services, IBM can better support clients’ digital transformation efforts and potentially leverage additional growth.
One area I am particularly interested in is quantum computing. Quantum computing promises to unlock enormous computing potential thanks to something called superposition: the ability of a quantum system to be in multiple states at once. In short, it means that huge calculations can be performed in virtually no time. The problem is that 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 important quantum research projects, such as the Fermilab-led initiative, which focuses on the development of superconducting quantum systems.
Furthermore, the global quantum computing market is expected to grow significantly, with projections pointing to an increase from $1.21 billion in 2023 to $12.62 billion in 2032, at a compound annual growth rate (CAGR) of 34.8%. This rapid growth rate 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.
I’m afraid IBM is expensive relative to expected growth. The stock is currently trading at a forward upside of 22.8x, which represents 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%.
Together this results in a price-earnings-growth ratio (PEG) of 4.43. Even taking into account the forward dividend yield of 2.9%, the stock still seems expensive. As such, IBM appears to be priced based on unrealized potential, whether in AI or quantum computing. Personally, I think this makes it a risky bet.
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. IBM’s average price target is $227.38, implying 4% upside potential.
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On paper, IBM doesn’t seem like a great value. The company is trading above its price target, and the PEG ratio is quite unpleasant, even when dividends are taken into account. There is of course potential in the very exciting segments of AI and quantum computing. However, I would say the price tag is currently too high to take the plunge and invest.
