IBM (IBM -1.05%) has been around for more than 100 years. While the tech giant still sells plenty of hardware, including its iconic mainframes, today, it's focused on software and consulting. As enterprises navigate an increasingly complex technological landscape, IBM provides solutions that can cut costs, boost productivity, and raise efficiency.
While IBM stock has been a dud for the past decade, there are a few reasons to believe that its long malaise is finally coming to an end.
1. Revenue can grow even in a tough economy
At its core, IBM helps its clients solve problems. The company has built long-term relationships -- some of which span decades -- with enterprises and organizations. Through its consulting arm, it crafts solutions that involve other IBM products as well as products from competitors. The company's hybrid cloud and AI platforms often take center stage, but strategic partnerships with the likes of Amazon Web Services and Microsoft have broadened the scope of what IBM can ultimately offer.
Given the uncertain state of the global economy, demand for some types of projects has weakened. One area where IBM is seeing sustained demand is digital transformation projects that aim to deliver well-defined cost savings or productivity gains. The company's signings grew by 50% year over year in the third quarter, with signings involving cloud platforms like AWS doubling. Red Hat's software, which forms to core of IBM's hybrid cloud platform, achieved signings of $1 billion.
Even if the economy deteriorates in 2024, enterprises will still be willing to spend on projects that can deliver quick payoffs in terms of cost savings or increased efficiency. While IBM isn't immune to economic conditions, it's capable of growing during a range of scenarios.
2. AI is a massive opportunity
IBM has been working on artificial intelligence for many years. When its Watson AI system won on Jeopardy! in 2011, it was a watershed moment for the AI industry. However, following that triumph, IBM struggled to commercialize its AI technology. It tried and failed to turn Watson into a household name, and efforts to apply the tech to areas like healthcare largely fizzled out.
The AI revolution kick-started by OpenAI's ChatGPT in late 2022 left IBM playing catch up. The company now has a new AI strategy. Through its watsonx AI platform, enterprises and organizations can train and deploy advanced AI models with critical safeguards in place. A client that must adhere to strict regulatory and data privacy standards can't just throw proprietary and customer data at a third-party AI service and hope that nothing goes wrong. IBM's watsonx provides the framework for those clients to build AI solutions while minimizing risk.
IBM's vast enterprise customer base and long-term relationships give it an advantage. AI also provides it with incremental revenue opportunities. The company's Code Assistant product, for example, can translate the ancient COBOL code that runs on IBM's legacy mainframe systems into modern Java code. This gives mainframe customers a way to modernize applications without moving away from the platform.
With the generative AI market expected to explode over the next decade to well over $1 trillion, the AI tailwind for IBM should not be underestimated.
3. The valuation is reasonable
IBM isn't the fastest-growing company. Its revenue is expected to grow by 3% to 5% this year (on a constant-currency basis), and mid-single-digit percentage annual revenue growth is what investors should expect. However, IBM should be more consistent now that it has shed underperforming businesses and repositioned itself around hybrid cloud and AI.
IBM expects to generate about $10.5 billion of free cash flow in 2023, and the company's market cap is roughly 14 times that. The shares are sitting near a multiyear high, so they are not as inexpensive as they have been over the past few years. But many of its peers are trading at far pricier valuations. Oracle, which has been struggling with growth recently, trades for 29 times trailing-12-month free cash flow. IBM stock looks like a steal in comparison.
As investors gain confidence that IBM can grow more consistently than it has in the recent past, the combination of rising earnings and a higher valuation multiple could drive the stock much higher in the years ahead.
