2024 Prediction: Why IBM Is the AI Stock to Buy and Hold for Magnificent Growth | The Motley Fool (2024)

It's 2024, and the stock market has been fascinated with artificial intelligence (AI) for a full year now. Stocks seen as direct plays on the AI trend have skyrocketed, especially if they have an early lead in some subsector of the AI revolution.

For instance, shares of AI-chip pioneer Nvidia (NVDA -0.95%) have more than tripled in 52 weeks. AI-based cybersecurity expert CrowdStrike Holdings (CRWD -1.07%) soared 177% higher over the same period. Data analytics specialist Palantir (PLTR -0.67%) made a 134% jump, also driven by its AI-powered products and services.

These AI-focused market darlings float on incredibly rich valuation ratios. The price-to-sales ratios in my sample groups start at 17 times trailing revenue for Palantir, stretching to 31 for Nvidia. Profit-based ratios are even wilder with price-to-free cash flow metrics in the mid-70s. CrowdStrike isn't even profitable in terms of earnings, reinvesting its operating income in growth-boosting AI research and heavy marketing budgets.

Yet, the AI surge left a couple of top-notch names behind. In particular, I think it's high time to consider investing in International Business Machines (IBM -1.58%) right now. This proven leader in business-grade AI tools never got the memo about soaring stock prices, and its shares look ridiculously undervalued today.

How IBM missed the AI bandwagon last year

I'm not here to remind you of IBM's illustrious history in AI research. That backdrop gives Big Blue another selling point to pull out in contract negotiations, but most deals aren't won by looking back at years gone by. So instead, let's talk about how IBM is pursuing the AI business today and in the future.

The IBM you see today bears little resemblance to the one-stop shop for information technology (IT) needs you got used to in the 1990s and early 2000s. The company refocused its considerable assets on so-called strategic imperatives under CEOs Ginni Rometty and Arvind Krishna. Over the years, the themes of cloud computing and AI emerged as the most important of these overarching goals. The company spun off or sold several slow-growth business operations that didn't fit the new mold, resulting in lower top-line sales but robust cash flows.

Many investors lost patience with this slow process, starting in 2012 and arguably still ongoing today. IBM's stock price fell more than 40% (not counting a temporary 48% drop in the early coronavirus panic) before starting a modest comeback. Even with the stock at today's multiyear highs, IBM investors have seen a 5% price drop since the end of 2011. The S&P 500 index rose by 277% over the same period, so Big Blue hasn't been a long-term market-beater.

And maybe that's why IBM's stock hasn't enjoyed raging gains in the recent AI frenzy. How can this long-term underperformer deliver valuable innovation in this fast-paced technology era?

...or did it?

That undervaluing is a big mistake in my view. You see, this is where IBM's rubber should hit the road. The company has spent years preparing for exactly this opportunity, quietly building an unmatched portfolio of business-to-business AI tools and services.

For example:

• IBM's Watson AI platform offers cloud-based services in data analysis, natural language processing, deep learning, and more. Based on 70 years of research and customer requests, this system was designed from the ground up to meet the needs of corporate customers.
• Following the ChatGPT furor, IBM added generative AI functions to its app development and data analytics platform, creating the new Watsonx platform. This system can take IBM's data-processing features, add your own business data, and produce actionable insights with game-changing business value. It's like ChatGPT in a business suit, always carrying a briefcase full of your company's most valuable data.
• Going forward, IBM benefits from selling its unique AI products to new and existing clients -- but also from helping customers make the most of their new AI tools. "We are the only provider today that provides an integrated technology IT stack around our Watsonx platform and brings to bear the consulting services expertise to actually help clients deploy and run their GenAI solutions," CFO Jim Kavanaugh said at a recent investor conference.

I can only scratch the surface of IBM's vast AI operations in this brief treatise. Many books have been written on this subject and the company receives thousands of AI patents every year, if you're looking for some light bedside reading. But I think it's clear that IBM has started to flex its robust AI muscles, most likely resulting in impressive business results in 2024 and beyond.

Enterprise-class clients may take some time putting new technology solutions though testing, budget approvals, and multilayer management approvals, but there will be consistently lucrative contracts at the end of that Big Blue rainbow.

Market makers are missing that behind-the-scenes success story so far, which is why IBM's stock only gained 14% over the last year and trades at just 2.5 times sales and 12.6 times free cash flow right now. Lifting these ratios just a little closer to the lofty appraisals of Nvidia, CrowdStrike, and Palantir would result in dramatic price gains -- at long last.

Seizing the AI opportunity with IBM

IBM's journey in the AI landscape has been a story of strategic transformation and undervalued potential. While market darlings have grabbed headlines with soaring valuations, IBM has quietly built a formidable AI arsenal, from the versatile Watson AI platform to the innovative Watsonx system tailored for business applications. This blend of cutting-edge technology and enterprise-focused solutions positions IBM uniquely in the AI domain, and the stock is essentially on fire sale.

It's an opportunity for investors to back a seasoned tech giant poised for a resurgence in the era of AI, at a valuation that leaves room for significant growth.

As we move further into 2024, keeping an eye on IBM's progress in deploying its AI solutions and capturing market share will be crucial. For those willing to look beyond the hype, IBM's value-priced stock looks like a smart and low-cost investment choice in the rapidly evolving AI sector.