IBM Fell 25% as Hardware Spending Dominated AI Budgets. Palantir Sells What Runs on Top.

Shares of IBM (NYSE: IBM) fell 25% on July 14 after the company released preliminary second-quarter results. CEO Arvind Krishna explained that customers shifted their spending toward servers, storage, and memory as hardware prices continued to rise.

This caused spending delays on numerous large software deals, primarily in its mainframe and transaction-processing business. While enterprise demand for artificial intelligence (AI) infrastructure takes center stage, Krishna declared that "value will increasingly shift toward the orchestration and data layers" on its earnings call.

Image source: The Motley Fool.

The pure-play advantage

IBM has been building the governance and control layer that an organization needs to run its own AI. At the same time, Palantir Technologies (NASDAQ: PLTR) has carved a position in the market by turning enterprise data into decisions.

IBM's AI-related software includes Sovereign Core for auditable runtime control and the recently acquired Confluent for data streaming. It also launched Lightwell, a $5 billion commitment to help clients address open-source vulnerabilities.

Even if these efforts are successful, the company remains a multisegment incumbent, where software, consulting, and infrastructure each follow their own cycles.

Palantir, on the other hand, is a pure play on this theme. Its platforms, including Foundry and the Artificial Intelligence Platform, integrate an organization's data and run AI-powered applications.

Is the pullback an entry point?

In May, Palantir posted revenue growth of 85%, its 11th consecutive quarter of acceleration. This drove strong operating leverage, as margins expanded from 44% to 60% year over year.

Existing customers continue to ramp up spending, with net dollar retention at 150% and total remaining deal value climbing 98% to nearly $12 billion.

The trade-off for this concentrated exposure is a rich valuation, as the stock trades at roughly 39 times this year's sales and 67 times free-cash-flow guidance. IBM is cheaper at just 17 times forward earnings, but not necessarily more attractive, as each segment will perform differently in an AI-enabled future.

Meanwhile, after a 30% drawdown this year, Palantir's shares are beginning to look more reasonable. The growth runway is impressive, and the cash keeps piling up, but I'm not quite ready to pull the trigger yet.

Bryan White has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends International Business Machines and Palantir Technologies. The Motley Fool has a disclosure policy.