Artificial intelligence (AI) is undoubtedly garnering a lot of attention at the moment. As it pertains to investments, much of the hype around AI surrounds the "Magnificent Seven" stocks -- a catchy moniker for the biggest names in tech: Apple, Microsoft, Alphabet, Nvidia, Amazon, Meta, and Tesla.
While each of these stocks has generated market-beating returns over the last year, savvy investors understand that there are a host of other emerging leaders in AI.
Although International Business Machines (IBM -1.05%) may not be growing at a commensurate level relative to other names in enterprise tech, the company has made some interesting investments over the last couple of years that appear to be paying off.
Let's dig into IBM's role in the AI landscape and assess if now is a good time to scoop up shares in this blue chip stock.
AI is changing in real time
Some of IBM's core AI tools live with its Watson computer system. Watson is a sophisticated platform that utilizes natural language processing and machine-learning models to answer questions. Although this is an impressive feature, Watson's latest AI development is what piqued my interest.
Applications for AI are unfolding at an unprecedented pace. Even lawmakers are grappling with the complexities and risks associated with the technology, and how to best regulate it. Just a few months ago, IBM released watsonx.governance -- a tool for AI compliance protocols.
While it's still nascent, major corporations such as accounting and consulting firm Deloitte have deployed the governance software in its risk management practice. Additional use cases for Watson's governance capabilities include financial services such as bill approval, as well as ethical hiring practices.
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IBM's role in artificial intelligence
Admittedly, IBM is a bit different from other enterprise technology businesses. The company was late to the game in cloud computing, lagging innovative solutions from Microsoft Azure, Amazon Web Services, and Google Cloud. However, its $34 billion acquisition of Red Hat in 2019 has helped it turn things around a bit.
What really sets IBM apart from the competition, however, is its consulting practice. "We continue to believe our consulting business will be an early beneficiary of AI," CEO Arvind Krishna stated during the company's fourth-quarter earnings call. "We are the only provider today that offers both a technology stack with our watsonx platform and consulting services for deploying and managing generative AI."
Generally speaking, software-as-a-service (SaaS) businesses primarily focus on selling subscriptions. Recurring software licenses generate steady, predictable revenue that tends to carry a high margin. By contrast, consulting services are typically non-recurring and come with much lower margin profiles compared to software. Therefore, many enterprise tech companies may shy away from a heavy focus on professional services.
But during the fourth quarter, one-third of the company's bookings related to generative AI came from software. The other two-thirds came from deals signed through the consulting arm. IBM's unique business model is actually turning the consulting operation into a channel for more software revenue, specifically in AI.
Should you invest in IBM stock?
IBM Revenue (Quarterly) data by YCharts.
The chart above depicts IBM's revenue, gross profit, and free cash flow on a quarterly basis over the last decade. It's easy to see that the company's financial trends have experienced some dramatic peaks and valleys over the last few years.
What's a little surprising, however, is the company's valuation. As of the time of this article, IBM stock trades at a forward price-to-earnings multiple of 18.5 -- well above the company's 10-year average of 14.7.
If you're looking to invest outside of the bigger names in AI, IBM could represent a solid long-term opportunity. However, while the company has some very interesting prospects in AI, it needs to prove that it can compete among other major players. In 2023, IBM's total revenue only grew by 2%, and the company guided for growth in the mid-single-digit percentages for this year.
With the stock soaring since IBM reported fourth-quarter earnings last week, I think it could be a little overbought. I see the company as well-positioned to benefit from rising demand in AI and think it's quietly becoming an influential player in the space. But with its valuation hovering around its highest level in a decade, my concern is that AI hype is priced into IBM at the moment.
Nevertheless, as the company continues to reinvent itself and make inroads in the ever-evolving landscape of generative AI, IBM certainly looks intriguing and could be worth keeping an eye on.
