IBM (NYSE:IBM) has become one of the unexpected beneficiaries of ‘AI mania,’ with IBM stock hitting price levels not seen since the early 2010s. Shares in this blue-chip have surged over the past year, driven by strong quarterly financial results and a successful AI growth strategy.
The market may be overestimating the AI boom’s impact on this company’s financial performance. Disappointment could strike down the road. Shares trading at a high multiple for a mature business may pose a significant downside risk.
IBM Stock: From Slump to Surge
Before the AI boom that took shape in 2023, International Business Machines could be best described as a “value trap” stock. Some investors may have found Big Blue appealing for its relatively high dividend and blue-chip status, but for investors focused on capital growth, shares were a lackluster choice.
For more than a decade, IBM stock performed poorly. We can chalk this up to deteriorating fundamentals. Many of the company’s business units experienced declining fiscal performance. Past management was unsuccessful in its turnaround efforts. After many failed starts, however, IBM may be finally making a comeback.
At least, that’s been the take-away among analysts and investors, following IBM’s last quarterly earnings release in late January. For the December quarter, the company revealed several positive surprises.
Not only did these include better-than-expected fiscal results and updates to guidance. CEO Arvind Krishna also provided promising statements regarding demand for IBM’s “AI book of business.”
In other words, IBM’s AI-related software and consulting sales. Since making these statements, sell-siders and the market have taken and ran with them. Analyst price targets have moved higher, and shares have moved closer to $200 per share than they’ve been seen since 2012.
Questionable Valuation Given Growth Prospects
To many, calling IBM stock “overvalued” may seem absurd. Despite the significant increase in share prices, Big Blue is currently trading at only 19 times forward earnings. This represents a discount to most of the “Magnificent Seven” stocks.
But while IBM may seem cheap on the surface, shares are in actuality quite pricey when you compare its current valuation with expected future growth. Yes, per sell side forecasts, IBM’s earnings are expected to rise by around 23.7% this year, from $8.14 to $10.07 per share.
However, based on forecasts for 2025 and 2026, earnings growth will decelerate back to the mid single-digits. Although IBM bulls may bet that results handily beat these forecasts (thanks to AI), as a Seeking Alpha commentator argued earlier this month, despite current sentiment, much suggests AI growth won’t move the needle much.
Why? Per the commentator, IBM’s “AI book of business,” while growing rapidly, made up less than 1% of overall sales last quarter. Even worse, a majority of this “book of business” consists of AI consulting engagements with limited scalability.
With this, it’s reasonable to say that this segment will not unexpectedly turn this “tech dinosaur” back into a growth dynamo.
The Verdict: Sell, as an ‘AI Bust’ Could Spell Doom for Shares
While not certain, besides perceiving it to be an AI winner in the making, those bullish on IBM may also believe that it is less risky than pricier peers.
However, while IBM may have a massive (but slow-growing) legacy business to fall back, don’t expect this to mitigate price declines, in the event today’s “AI boom” turns into an “AI bust.”
If this occurs, the market will likely send shares back to their historic valuation (10-15 times earnings). This suggests a potential price reversal of nearly 50%. Even if bullishness for the AI trend continues, if the growth resurgence stalls in the coming quarters, a big reversal is still very possible.
Bottom line: With greater downside risk that it seems at first glance, instead of joining the IBM stock wave, sell into strength if you own it, and steer clear if you’ve yet to enter a position.
On the date of publication, Thomas Niel did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
