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Here's Why IBM's AI Growth Makes It a Stock to Buy Now

Source The Motley Fool

There are many reasons to invest in IBM (NYSE: IBM) these days. The centennial tech giant is a leading researcher in quantum computing. The stock trades at modest valuation ratios, like 18.5 times free cash flow and 21.6 times forward earnings. And Big Blue's 2.8% dividend yield is more than twice the average among S&P 500 (SNPINDEX: ^GSPC) stocks.

But one piece of my investment thesis for IBM weighs heavier than the rest. Above all, IBM is a powerhouse in business-class artificial intelligence (AI). The company has been preparing itself for this unique point in computing history, and AI growth should drive IBM stock much higher in the next few years.

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IBM quietly built a billion-dollar AI business

IBM was quick to respond when OpenAI unleashed ChatGPT in November 2022. Six months later, Big Blue released the Watsonx platform of generative AI tools for corporate clients.

This system was always different from consumer-facing large language models (LLMs) such as ChatGPT or Alphabet's (NASDAQ: GOOG) (NASDAQ: GOOGL) Gemini. The IBM tools are focused squarely on enterprise-class customers, with features that your average consumer probably wouldn't care about.

Watsonx's data flows can be audited, from LLM-training inputs to final chatbot outputs. It was built to draw actionable conclusions directly from a company's proprietary information, while also protecting that information from outside access. This is a business tool, not a plaything.

Sales were slow at first. Software and service buyers in this category often insist on deep testing of any prospective big-ticket investment. The budgets also need rubber stamps, often from several layers of management. This stuff takes time, so IBM didn't exactly race out of the generative AI starting gates.

But the company reported more than $1 billion of Watsonx-based contracts in the first quarter of 2024 -- less than a year later. That "book of business" doubled to $2 billion in the next report, stepping up to $3 billion in the third quarter and over $5 billion by the end of the year.

The generative AI business is picking up steam quickly.

An unmatched consulting advantage

I'm not talking about straight-up software licenses. IBM supplements its software with a much larger helping of consulting services. About 80% of the order book held generative AI consulting contracts in the fourth quarter.

This is a business advantage other AI providers aren't even trying to copy. Microsoft (NASDAQ: MSFT) doesn't even mention its consulting business in recent earnings calls. The term was last mentioned in passing in January, 2023. It's just not a big deal to Microsoft. Alphabet spends even less conference-call time on consulting concepts, and the same goes for Amazon (NASDAQ: AMZN).

Consulting services are an afterthought for many tech titans. For IBM, they're a core business concept driving massive long-term contract values. In fact, many companies turn to IBM for support and integration services around their AI systems from other systems.

IBM's AI story is just getting started

A $5 billion list of multiyear orders is still a drop in IBM's giant revenue bucket. The company collected $62.8 billion of top-line sales last year, generating $12.7 billion of free cash flow. But the AI-driven portion is growing quickly, and I can't wait to see how Watsonx's business develops in the long run.

This stock could double its cash flow-based valuation and still look like a bargain next to Amazon or Microsoft. Like IBM's business model, investors are taking their sweet time to embrace this unsung AI hero. That's fine, since it gives me more time to pick up IBM stock on the cheap. IBM remains one of my favorite AI investments in March 2025.

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John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Anders Bylund has positions in Alphabet, Amazon, and International Business Machines. The Motley Fool has positions in and recommends Alphabet, Amazon, International Business Machines, and Microsoft. The Motley Fool recommends the following options: long January 2026 $395 calls on Microsoft and short January 2026 $405 calls on Microsoft. The Motley Fool has a disclosure policy.

Disclaimer: For information purposes only. Past performance is not indicative of future results.

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