Watsonx Can Help IBM Stock Gain Lost Ground

Computing behemoth IBM (NYSE:IBM) has gained close to 4% year-to-date in 2024, underperforming the broader Nasdaq-100 which gained about 14% over the same period. In contrast, IBM’s peer Oracle stock (NYSE:ORCL) has gained 19% year-to-date. IBM posted mixed Q1 2024 results last month, with revenue growing just 1.5% year-over-year to $14.46 billion, missing estimates as the consulting and infrastructure business slowed down, although the software business fared reasonably well. However, the focus for investors has been on IBM’s artificial intelligence business, which is seeing a lot of interest as big companies look to deploy AI into their applications and software.

IBM has been a pioneer in the AI space, with several notable contributions in the field including the Deep Blue supercomputer that defeated world chess champion Garry Kasparov in the 1990s and the Watson AI system that beat champions in the game of Jeopardy. Now, following the success of ChatGPT AI bot and other large language models, the world has been increasingly focused on generative AI technologies. While big tech titans such as Google and Microsoft focus on more generic large models geared toward the public, IBM is looking to help enterprise customers with customized AI models for their businesses. IBM’s watsonx platform enables companies to train, tune, validate, and deploy customized AI models for their business applications while accounting for legal and regulatory concerns. IBM has indicated that it has booked over $1 billion for its generative AI business since its inception, with the consulting side of the business seeing considerable gains as IBM guides customers on implementing AI-related software. IBM has been focusing on a more collaborative approach to scale its AI tools via partnerships with Amazon’s AWS, Meta, Microsoft, Salesforce, as well as SAP, who can integrate their software or co-develop for watsonx. This open model could help IBM win over more business and cater to a larger base of customers irrespective of their IT setup and platforms. IBM has also been focusing on deploying AI-assisted programming tools, which are currently viewed as productive uses of AI.

The interest surrounding generative AI has resulted in IBM stock showing strong gains of 35% from levels of $125 in early January 2021 to around $170 now, vs. an increase of about 40% for the S&P 500 over this roughly 3-year period. IBM is one of a handful of stocks that have increased their value in each of the last 3 years, but that still wasn’t enough for it to consistently beat the market. Returns for the stock were 6% in 2021, 5% in 2022, and 16% in 2023. In comparison, returns for the S&P 500 have been 27% in 2021, -19% in 2022, and 24% in 2023 – indicating that IBM underperformed the S&P in 2021 and 2023. In fact, consistently beating the S&P 500 – in good times and bad – has been difficult over recent years for individual stocks; for heavyweights in the Information Technology sector including MSFT, AAPL, and NVDA, and even for the megacap stars GOOG, TSLA, and AMZN.

In contrast, the Trefis High Quality (HQ) Portfolio, with a collection of 30 stocks, has outperformed the S&P 500 each year over the same period. Why is that? As a group, HQ Portfolio stocks provided better returns with less risk versus the benchmark index; less of a roller-coaster ride as evident in HQ Portfolio performance metrics. Given the current uncertain macroeconomic environment with high oil prices and elevated interest rates, could IBM face a similar situation as it did in 2021 and 2023 and underperform the S&P over the next 12 months – or will it see a strong jump?

At the current market price of about $171 per share, IBM stock trades at close to 17x consensus 2024 earnings. Although IBM’s growth rates have been lackluster, we think this is a fair valuation, given that IBM is focusing on core areas such as cloud computing, AI, and automation after divesting its legacy business. IBM is also making mid-size acquisitions to bolster its portfolio of higher-margin software products. We value IBM stock at $180 per share, which is slightly ahead of the current market price.  See our analysis  IBM Valuation: Expensive or Cheap for more details on what’s driving our price estimate for IBM. Also, check out the analysis of IBM Revenue for more details on how IBM revenues are trending.

[1] Returns as of 5/28/2024
[2] Cumulative total returns since the end of 2016

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