IBM: A Reality Check
$IBM(IBM)$ ’s stock performance surged after its Q3 2024 earnings report, behaving more like a prominent AI software player than a tech giant with substantial legacy businesses, mainly in consulting.
However, IBM’s traditional operations are unlikely to benefit significantly from the AI boom. Given another lackluster quarter, IBM might not be worth the bullish outlook.
Stagnant Growth Amid AI Push
Despite repeated promises of pivoting to growth sectors, IBM hasn’t achieved substantial sales momentum. The latest quarterly report revealed a revenue increase of only 1.5% year-over-year, falling short of expectations.
IBM's AI software business shows promise, but with an existing $60 billion revenue base, adding a few billion won’t ignite substantial growth. IBM hasn’t even claimed AI-driven revenue increases for its software sector, casting doubt on the recent stock price surge to historic highs.
Consulting remains IBM's mainstay, yet with limited profit margins—just 28%. Most generative AI deals fall under consulting, but with an order ratio of 1.14, significant profit growth seems unlikely. IBM’s Q4 revenue guidance aligns with Q3’s 1.5% growth, despite launching its AI software business over a year ago and signing major AI deals.
IBM projects $12 billion in free cash flow for 2024, with a market valuation soaring to $215 billion. The company spent nearly $3 billion in recent deals, leaving its balance sheet weakened, with only $14 billion in cash and $46 billion in debt. IBM’s annual $6 billion in dividends and acquisition costs deplete its remaining cash.
Valuation Concerns
Trading at 22 times its 2025 earnings target of $10.73 per share, IBM’s stock appears pricey. Analysts predict minimal EPS growth in the coming years, likely due to IBM's unfavorable profit margin math, despite a growing AI order book.
IBM’s valuation stands at 3-4 times its projected growth rate, making it notably expensive. To justify its current price—let alone its recent highs—IBM needs sustainable growth above 10% across its business.
A more realistic valuation would peg IBM at 15 times its EPS target, bringing the stock down to around $150, close to its pre-AI hype level.
The AI Hype Reality
IBM’s recent rally seems more about AI hype than tangible AI-driven financial gains. With a soft Q4 forecast and a high valuation multiple, IBM may soon face the reality of being a legacy tech company with limited returns from AI.
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