Better Artificial Intelligence (AI) Stock: Nvidia vs. IBM

The boom in generative artificial intelligence (AI) has ushered in a golden age for the chip designer Nvidia (NVDA 1.40%) and its investors. Software and Services Veteran IBM (IBM -0.09%) also benefits from the same trend, but in a very different way.

Which of these tech titans is the best AI stock in the summer of 2024? Let’s take a look.

Nvidia’s generative AI bonanza

Nvidia wasn’t a very interesting story before the generative AI boom. Two years ago, the company tried its best to distance itself from cryptocurrency mining, and the increased consumer interest in locking in video game equipment was fading. Nvidia already shipped tons of AI acceleration chips behind the scenes, but with limited fanfare because no one had seen ChatGPT yet. If anything, Nvidia’s involvement in autonomous vehicle systems looked like a promising growth catalyst back then.

Oh, how times have changed.

ChatGPT’s artificial brain is known to have been built around Nvidia chips, and the company has quickly emerged as the go-to provider of AI accelerator hardware. An Nvidia A100, H100, or L40S accelerator card costs between $8,000 and $30,000. You need tens of thousands of these products to train a modern large language model (LLM). Those chip sales come in large, profitable batches.

Thus, Nvidia’s sales rose 262% year-over-year in May’s first-quarter report. Data center sales, including the aforementioned AI accelerators, accounted for 87% of these revenues. That’s up from 60 percent a year ago and 45 percent a year earlier.

As a result, Nvidia’s revenue and cash flow are skyrocketing. So is the share price. Nvidia investors enjoyed a tenfold increase in their stake from two-year lows in October 2022.

The stock is obviously rising for good reason, but AI excitement feels a little overheated. Whether you’re looking at price-to-sales, price-to-earnings, or price-to-free cash flow, Nvidia is trading well above its long-term valuation averages.

In short, Nvidia looks overvalued despite the financial growth. I’d be a buyer again if the stock dropped dramatically, but I cashed in some of my Nvidia profits in the spring and it’s nothing more than a “hold” idea at this point.

How IBM’s drastic change in strategy is paying off

Unlike Nvidia, Big Blue isn’t a hardware vendor these days. That is, its single mainframe systems still provide some exposure to the hardware side of the tech world, but the company as a whole has refocused on software and services.

Because of its exclusive focus on business-class customers, the market has been a little slow to give IBM credit for its AI prospects. Enterprise-scale customers must put new software tools through performance, security, and integration tests while seeking budget approvals from multiple levels of management. It takes time, but the resulting contracts tend to be robust and long-lasting.

That’s where the company is today. Many testing and approval processes have run their course, and IBM is starting to generate serious sales from its AI solutions under the Watson banner.

In its second-quarter report in July, IBM reported $2 billion in generative AI orders, up from zero a year ago, as its core Watsonx service launched in the summer of 2023. Management and raised its full-year software growth guidance from the mid-single digits. to a large figure — an impressive boost since more than 80 percent of IBM’s software sales are tied to multi-year contracts. And CEO Arvind Krishna expects the growth rate to rise into double-digit territory in 2025 and beyond.

Big Blue’s AI boost is milder than Nvidia’s, but I also expect it to have more staying power. Sudden bursts of chip sales are one thing. A rising tide of long-term software contracts is a different animal. I prefer to invest in the slower burn with long lasting consequences.

And then there’s the valuation angle. In addition to Nvidia’s high multiples, IBM’s valuation ratios look like a fire sale:

NVDA PS Ratio data by YCharts

Why IBM is a better AI stock to buy today than Nvidia

I still own some of my old Nvidia stock, but I’m not looking to buy more anytime soon. New money is much more likely to go into my IBM position, as that tech titan still looks undervalued.

Wall Street is slow to forgive IBM for a decade-long shift in strategy, though I’d argue it was exactly the right move at the right time. The next few years should show investors how well the new focus on software, services, cloud computing and AI will work in the long run. This is a great AI stock to buy now and hold for decades.

And at the same time, Nvidia seems headed for a sharp price correction. Call me back when that stock has dropped at least 30% and preferably even more.

While Nvidia’s rapid growth is impressive, its valuation is too high. Meanwhile, IBM offers a more stable growth story as its radical change in strategy begins to pay dividends, making it an attractive option for new investment.

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