International Business Machines | IBM
Trade #3 2025
Trade Idea
IBM's stock has experienced a notable acceleration in valuation since mid-2023, reaching a 10-year high. This acceleration can be attributed to its strategic emphasis on AI, resulting in increased demand for its offerings, coupled with strong financial performance and favourable analyst assessments. IBM's Q4 2024 earnings report was published on January 29, 2025, for the fourth quarter of 2024. They highlighted exceeding EPS and revenue expectations, with strong growth in software, particularly Red Hat, and a significant expansion in the generative AI business, reaching over $5 billion in bookings.
Our models show the potential for a short-term correction and a longer-term appreciation.
Put options with maturity at the end of February and a strike of 245 (present price around 26) could profit from a transient increase of volatility and a transitory reversal.
Given the longer bullish trend, we expect a possible change of regime to a volatile plateau or drawdown in May and then beginning in August 2025. This suggests long call options with maturity at the end of May or longer with a strike in the range of 330-340.
IBM's Market Valuation Surge Since Mid-2023: Key Drivers and Challenges
IBM's stock price saw significant growth starting mid-2023, driven by its strategic focus on AI, hybrid cloud, cost efficiencies, and financial resilience. The following key factors contributed to this valuation shift:
AI and Generative AI Expansion - IBM capitalised on AI momentum with its Watsonx platform, growing its generative AI business to over $3 billion by 2024. The company strengthened its AI consulting services, leveraging Red Hat's software to drive adoption. Market enthusiasm around AI, fueled by innovations like OpenAI's ChatGPT, further bolstered investor confidence.
Strength in Software and Hybrid Cloud - IBM's hybrid cloud solutions gained traction as enterprises sought integrated IT environments. Red Hat, acquired in 2019, consistently delivered double-digit growth, reassuring investors of IBM’s transition from legacy hardware to software-driven revenue. Strategic partnerships with AWS and Microsoft expanded IBM’s market presence.
Operational Efficiency and Cost-Cutting - IBM implemented workforce rebalancing and divested underperforming units, improving profit margins. The focus on high-growth areas like AI and cloud contributed to an 83% gross margin in software, enhancing overall financial health.
Economic Resilience and Defensive Market Positioning - IBM's recurring revenue model (subscriptions and services) provided stability in uncertain economic conditions. Demand for cost-saving enterprise solutions remained strong, and its stock valuation (14x free cash flow in 2023) was attractive compared to competitors like Oracle (29x).
Financial Performance and Market Guidance - IBM consistently exceeded earnings expectations, generating $11 billion in free cash flow in 2023. Forward guidance projected mid-single-digit revenue growth for 2024, reinforcing investor optimism. Stock buybacks and dividends further boosted confidence.
Strategic Acquisitions and Partnerships - IBM strengthened its AI and cloud portfolio through acquisitions and expanded into Oracle consulting services. Collaborations with AWS and Microsoft enhanced its enterprise offerings.
Critical Considerations and Risks:
While IBM successfully positioned itself in the AI-driven market, concerns remain about its execution in AI, given past struggles (e.g., Watson in healthcare). Macroeconomic risks (interest rates, global slowdowns) could impact enterprise IT spending, and IBM’s valuation increased to 3.7x trailing revenues by 2025—higher than its historical average of 2.2x—raising questions about sustained growth.