Contemplating an Investment in Artificial Intelligence Stocks Prior to 2025?

A skeptical market is starting to view International Business Machines (IBM) as a major player in the artificial intelligence (AI) sector. As a result, IBM's stock has seen a market-beating 37% increase in 2024, or 44% if you consider total returns with reinvested dividends.

However, with such a quick rise, one may wonder if IBM is still a worthwhile investment, or if its growth engine is running out of steam. Let's analyze the company and its stock as we approach 2025.

Don't judge IBM by its first impression

At a glance, IBM's recent financial figures may not seem impressive.

Revenue increased by a mere 2% year over year in the third-quarter report. This increase is solely due to foreign exchange effects. Earnings per share (EPS) were 5% higher, partly thanks to a reduced tax rate. This is a stable and predictable report that aligns with analyst expectations, but it's nothing to get excited about.

But upon closer examination, IBM's flat results are somewhat impressive. The infrastructure segment saw a 7% revenue decrease, mainly led by a 19% decline in the highly cyclical IBM Z mainframe business. This division is closely tied to mainframe product cycles, and the next refresh of IBM Z systems is slated for 2025. This update is expected to include more advanced AI features powered by IBM's custom AI chips.

IBM

On the bright side, IBM's software and services segments held their own. Automation revenues rose by 13%, the Red Hat hybrid cloud business grew by 14%, and AI revenues were up 5%.

16.5

So, while AI is supposed to be a significant growth driver, it's great to see other components contribute to offsetting the anticipated mainframe slowdown. But why is AI growth limited?

3.3

IBM's long-term strategy in AI contracts

$207 billion

Here's the thing: IBM doesn't make quick sales. Instead, it focuses on setting up long-term subscription and technical support contracts. Establishing complex ideas, such as generating AI systems, can be a lengthy process. Many potential clients go through multiple rounds of technical testing, management approvals, and budget processes before committing.

However, once they do, IBM secures a loyal customer for the long term.

Nvidia

In the spring of 2023, IBM launched a generative AI platform called watsonx. By the following year, watsonx had secured more than $2 billion in firm multiyear contracts.

58.3

Just three months later, the watsonx order book increased by another $1 billion. This is a 50% increase in three months, or what is known as a tipping point. Over time, IBM will convert these contracts into cash sales while also signing more AI deals.

29.1

IBM is prepped for takeoff after a decade-long preparation

$3.30 trillion

This dynamic has been evident since watsonx was introduced. This is how IBM operates, and you're witnessing the company finally reap the rewards of a strategy shift that has been in the works for nearly a decade.

And the upcoming AI-enhanced System Z mainframes in 2025 will represent the positive half of a multiyear business cycle. By combining this business driver with the AI contract activity, sales and cash flows should significantly increase.

Microsoft

"Our portfolio is well-positioned to deliver an upward inflection in growth in 2025," IBM CEO Arvind Krishna said during the third-quarter earnings call. This is essentially saying that IBM's results should impress Wall Street in 2025.

44.7

IBM is a bargain in the booming AI market

12.8

The recent price increases have also increased IBM's valuation ratios. However, IBM shares remain affordable compared to other AI titans, particularly when focusing on cash profits. Whether you compare each stock by price to free cash flow or price to sales, IBM is a steal compared to Nvidia or Microsoft.

$3.2 trillion

I'm enthusiastic about the AI revolution and enjoy taking a patient approach to investing in this transformative technology. As a result, I strongly advise considering IBM shares while they are reasonably priced. Nvidia and Microsoft can wait.

Next year's business growth should surpass 2024's modest gains, especially if you keep an eye on IBM's forward-thinking watsonx contracts.

Despite IBM's recent financial figures appearing unimpressive at first glance, a closer look reveals that the infrastructure segment's decline is partially due to the cyclical IBM Z mainframe business, which is expected to see an update with advanced AI features in 2025. With such long-term AI contracts in place, IBM is well-positioned to reap benefits in the coming years, making it an attractive investment opportunity in the booming AI market.

Given IBM's focus on establishing long-term subscription and technical support contracts in the AI field, along with its affordable valuation ratios compared to other AI titans, investing in IBM shares could be a strategic move as it approaches the expected growth in its AI-enhanced System Z mainframes in 2025.