It's been a long road for International Business Machines (IBM -0.82%) investors. The company kicked off a transformation effort more than a decade ago, forced to adapt to a tech industry that was rapidly embracing cloud computing. Years of inconsistent results followed as the company exited businesses and spent many billions of dollars on acquisitions.
Some initiatives, like the company's early efforts to apply artificial intelligence (AI) technology to healthcare, were abject failures. Others, like the acquisition of software company Red Hat, have been roaring successes.
IBM has leaned into high-margin software while using its consulting business to help drive adoption. Its hybrid cloud and AI software platforms are at the center of the company's best long-term growth opportunities. Red Hat software revenue soared 17% year over year in the fourth quarter, and IBM surpassed $5 billion in cumulative bookings for generative AI-related business. Over the past couple of years, things have finally been clicking.
The stock has responded to IBM's improving fortunes by soaring to an all-time high. Shares of IBM were up more than 10% by midday Thursday following the fourth-quarter report, carving out a new all-time high in the process. The stock has risen by about 90% over the past three years, and it's now up around 36% over the past year alone.
With IBM stock finally breaking out of its funk and trading at record levels, should investors buy into the growth story?
A winning strategy
At its core, IBM's mission is to enable its clients to grow revenue, improve productivity, and boost efficiency. The company does this through software, consulting, and hardware. Software has become the largest component of IBM's revenue, accounting for about 45% of the total.
While IBM's software business generates high profit margins, the consulting business does a lot of the heavy lifting. Consulting is a less profitable affair, but it helps drive adoption of IBM's software platforms and products. For example, of the $5 billion in generative AI bookings the company has amassed, about $4 billion of that total were in the form of consulting signings.
IBM has embraced strategic partnerships with other technology companies, paving the way for new business that the company wouldn't have otherwise won. Since many enterprises are already using Amazon's AWS or Microsoft Azure for cloud computing, much of IBM's software can be deployed anywhere, and its consulting business is free to craft solutions that make use of those cloud platforms. A company that wants to modernize its IT infrastructure by moving some workloads to AWS, for example, can turn to IBM for its consulting services and its hybrid cloud platform.
The hardware segment isn't as important for IBM as it once was, but it's still a key part of the company's strategy. IBM's mainframe systems continue to enjoy wide use across certain industries, including financial services, and the latest z16 mainframe family has been the most successful mainframe generation in the company's history.
Beyond mainframe sales, IBM can sell additional products to mainframe customers. One example is the watsonx Code Assistant for Z, a generative AI tool that helps mainframe customers modernize legacy applications.
Accelerating growth and a reasonable valuation
IBM grew revenue by 3% in 2024, adjusted for currency. This year, the company expects revenue growth to accelerate to at least 5%. A booming software business will help the cause. Software revenue rose by 9% last year, and IBM expects growth to approach double digits again in 2025.
Consulting has been a mixed bag, with plenty of demand for digital transformations offset by weakness in more discretionary areas. Demand for AI consulting services could help return the segment to growth in 2025, although there are a lot of moving parts. Lastly, a new mainframe family is set to launch this year, which will contribute about 1 percentage point of revenue growth.
IBM expects to generate free cash flow of $13.5 billion this year, up from $12.7 billion in 2024. Based on the current market capitalization, IBM stock trades for roughly 17.5 times that free cash flow guidance. The stock isn't a clear-cut bargain, but it's not expensive either.
IBM is far from the fastest-growing tech giant, but the company has returned to consistent and sustainable growth. Revenue growth is accelerating as IBM's bets on hybrid cloud computing and AI pay off, and profit margins are expanding as well. IBM's valuation isn't as attractive as it was a year ago, but even at an all-time high, long-term investors should seriously consider adding IBM to their portfolios.
