Prediction: This under-the-radar tech stock will overtake Nvidia and Apple by 2030

Giants of technology Apple (AAPL -0.68%) and Nvidia (NVDA -2.10%) I’m on top of the world these days. These are the two most valuable stocks on the market, looking back at their market-beating returns over the past five years. Apple’s total return has delivered a compound average growth rate (CAGR) of 36% over that period. Nvidia has grown even higher with a five-year CAGR of 100%. The artificial intelligence (AI) boom has been very kind to Nvidia’s investors.

They made these massive gains in a strong era for the overall market, but S&P 500 the index looks downright sleepy by comparison:

AAPL Total Return Level data by YCharts

It would be great if Nvidia and Apple were ready to continue their methods of beating the market here. Invest in the biggest and baddest names on the market, sit back and relax and let them deliver more of the same good stuff for years to come. Unfortunately, I’m afraid both stocks are a bit overvalued at today’s massive market caps — $3.1 trillion for Nvidia and $3.4 trillion for Apple. I know it’s like comparing mountains of cash to rivers of revenue, but these two market caps add up to about 23% of America’s gross domestic product.

I think it’s too much. Apple and Nvidia could be overdue for a painful fix. At best, I don’t expect it to rise much higher in the near future.

At the same time, good old International Business Machines (IBM -0.14%) is gaining ground in the AI ​​space, and its stock is undervalued today. I don’t expect IBM stock to break the trillion-dollar mark in the next five years, but it should certainly rise as Big Blue’s enterprise-class AI tools add value to the stock. Most investors don’t yet see this traditional computing giant as a promising AI investment. It’s a big mistake.

Don’t forget IBM’s cash-profit advantages

IBM’s valuation ratios don’t look terribly interesting at first glance. Shares are changing hands at 22 times earnings and 2.9 times sales. These are perfectly acceptable middle values ​​for mature companies, just below the averages observed in S&P 500 and Dow Jones Industrial Average market indices.

Then the eye slides over to IBM’s price-to-free cash flow (P/FCF) ratio and the stock suddenly looks different. When you calculate IBM’s values ​​based on its massive cash profit, the stock looks like it belongs instead in Wall Street’s bargain bin. That ratio stops at 14 times free cash flow, just over half of the S&P 500 or Dow Jones‘ readings.

Cash is king, and IBM has plenty of it. The company’s cash-rich profits and relatively modest financial gains show that Big Blue’s accountants are very good at shrinking taxable profits while putting lots of real greenbacks in the bank. I see cash flow as a high-quality measure of profitability, so it’s easy to look away from IBM’s moderate price-to-earnings ratio.

IBM’s place in the AI ​​boom

Remember the five-year chart I showed you? IBM’s chart for the same period is a different animal:

IBM Total Return Level data by YCharts

The stock has underperformed broad market indexes for many years as it has transformed a hardware-heavy business model into a more profitable software and services plan. In particular, you should know that the revamped Big Blue comes with a strong focus on cloud computing, data security and AI tools.

Yes, this company was a leading AI researcher long before the launch of ChatGPT opened the floodgates for AI investment. Many investors seem to have missed this connection, as IBM’s business results have not immediately increased in this booming AI era. The big AI contracts are coming, just a little late.

You see, IBM is happy to leave consumer-friendly ideas like ChatGPT-style chatbots to other technology vendors. This company will always pursue large corporate contracts, adding additional layers of security, business-friendly data analytics and process-defying data tracking. Potential customers may take a few quarters to test and approve the resulting AI recipe, but the end result is a profitable long-term business that won’t be easily replaced.

Approvals are available now, creating a robust long-term revenue stream. Market makers still aren’t paying attention, so IBM stock continues to trade at incredibly low cash flow ratios. I can’t wait to see what happens in a few years when AI contracts have become generous and very profitable revenue streams.

One more thing…

Granted, Nvidia and Apple also make solid cash returns. However, their high share prices already account for these high-quality returns. Apple’s P/FCF ratio stands at 33 today, and Nvidia’s stands at 79 times free cash flow.

Thanks, but no thanks. I’d rather buy IBM’s undervalued stock.