2023-09-24 03:33:15 ET
Summary
- On the face of it, IBM looks like a value stock: High yield, low P/E.
- But IBM is transitioning their business, and one field in particular - quantum computing - offers exciting prospects for the future.
- In this analysis, I discuss what leading the charge in the next computer industry revolution could be worth to investors.
Quantum supremacy: The ultimate goal of IBM's foray into quantum computing
International Business Machines Corporation (IBM) is often considered a value stock in the investment community because of its high dividend yield and comparatively low forward P/E multiple.
But IBM could be a growth stock because of the past several years of corporate action taken by management to radically alter the business segments of the company. These actions include early steps to transition from making PCs to more recent ones like buying Red Hat and other software services firms. The general transition from hardware to software services has rendered IBM as of today somewhat unrecognizable from that of several decades ago - and certainly from the company that was actually founded more than a hundred years ago. But it's starting to pay off with IBM having grown revenues for fiscal year 2022 as opposed to the prior couple of years' stagnation.
IBM does remain partly a hardware company, though. One area of focus is that of quantum computing.
Because of the vast opportunities in this particular field, my focus with this analysis is to assess the potential for rewards to investors if IBM manages to fulfil their potential within quantum computing.
Before getting ahead of ourselves, though, let's take a look at what quantum computing is and why it's important.
To understand quantum computing, you first have to understand conventional computing. Put very simply, a conventional computer - like the one you're using to read this analysis - runs on microchips to process computations. The basic unit in this computation is the binary digit (or "bit") which represents a logical state with one of two possible values. These values are most commonly represented as zeros and ones (1 / 0). Other representations are used widely as well, such as true/false or +/-.
Quantum computers , on the other hand, don't rely on microchips for processing but instead take advantage of quantum mechanical phenomena. The basic unit in the computation of a quantum computer is a qubit (instead of a classical bit). A qubit can exist in a superposition of its two basis states - which loosely means it has more capabilities than just the true or false position. The idea is that because of this attribute, quantum computers should eventually be able to compute tasks that conventional computers can't.
The prospects of this are exciting because it would mean that even the most advanced conventional computer with the most advanced chips for processing would not be able to complete the task that the qubit-based quantum computer would - or perhaps it would, but not within what scientists refer to "any reasonable amount of time". The implications of this could be enormous - including potentially powering the next-generation wave of artificial intelligence. Perhaps quantum computing is what we need to actually make computers smarter than humans.
The point at which a quantum computer can compute a task that a conventional computer would never be able to - or not within any realistic timeframe - is referred to as " quantum supremacy " or the "quantum advantage". This is essentially the point at which we'll enter a new stage of computing. It is expected that the capabilities of quantum computing could one day help solve some of the world's most pressing challenges including climate change.
IBM is widely considered the industry leader in quantum computing. It has already built over 20 actual quantum computers. For comparison, Microsoft (NASDAQ: MSFT ), who also have ambitions in the field, is yet to build even one (although they are in the process of it).
In terms of what it would take to develop a quantum computer that actually has more commercial viability than the ones currently in existence, IBM has laid out a roadmap illustrating their goals which I will outline below:
Year | Milestone |
2019 | Run quantum circuits on the IBM cloud |
2020 | Demonstrate and prototype quantum algorithms and applications |
2021 | Run quantum programs 100x faster with Qiskit Runtime |
2022 | Bring dynamic circuits to Qiskit Runtime to unlock more computations |
2023 | Enhancing applications with elastic computing and parallelization of Qiskit Runtime |
2024 | Improve accuracy of Qiskit Runtime with scalable error mitigation |
2025 | Scale quantum applications with circuit knitting toolbox controlling Qiskit Runtime |
Beyond 2026 | Increase accuracy and speed of quantum workflows with integration of error correction into Qiskit Runtime |
Currently, the best quantum computer IBM has is the Osprey. It runs a 433 qubit system. IBM is set to launch Condor in 2023 running a 1,121 qubit system. IBM aims to scale to 10K-100K qubit by 2026 and beyond. Accelerating the amount of qubits is essential to developing a quantum computer capable of computing tasks that conventional computers can't.
Before getting into the investment value the field of quantum computing could hold to investors, I want to touch upon the comparison I was making in the headline of this analysis.
Why I'm comparing IBM to Nvidia: Nvidia's product used to have little application, too
The most advanced chips powering AI today are mostly made by US chipmaker Nvidia (NASDAQ: NVDA ). The advance of AI, particularly in the past few years, has driven demand for Nvidia's chips to all-time highs with the stock price following suit.
But Nvidia was founded in 1993 way before any practical application of artificial intelligence existed. Back then, the vision for Nvidia was to enter the field of accelerated computing such as graphics-based computing for its ability to solve problems that general purpose computers couldn't (sound familiar?). At the same time, the founders realized that graphics-based computing such as video games was among the most challenging problems for computers at the time. This meant that Nvidia's chips had some practical application - but to a much lower degree than they now have with even more challenging computational problems arising out of AI-based software. Speaking on this issue, Nvidia CEO Jensen Huang said in a recent interview :
We created this thing called accelerated computing. And that was what we pioneered about 3 decades ago. And it's taken until now to really take off. - Jensen Huang, CEO, Nvidia
So it's clear that as much as Nvidia's success and the meaningfulness of their product are evident now, but it's taken a long time to get to this point. Decades even.
The point I want to get to here is that IBM is essentially trying to do what Nvidia tried doing three decades ago - which is to once again revolutionize the field of computing. Whether they're successful or not remains to be seen, and whatever happens, it's going to take a long time to unfold. Which gets me to the discussion of what being successful in this field is even worth.
What being the first mover in quantum computing could mean to IBM's value
Before we get into trying to assess the value of a successful foray into commercially viable quantum computing, let's first look at IBM's valuation as determined by the market versus its tech peers.
I'm using forward P/Es from Seeking Alpha:
Company | FWD P/E |
IBM | ~15 |
Microsoft | ~29 |
Alphabet | ~23 |
IonQ | Neg. |
Nvidia | ~38 |
It's obvious from the above that IBM trades at a relatively large discount to its peers. But then again, there's a pretty big difference between the businesses of say IBM and Alphabet - for instance, IBM generates a significant portion of their revenue through consulting, with Alphabet's main revenue driver obviously being its search engine Google. But with a FWD P/E of ~15, suffice to say that the market is relatively skeptical of IBM's growth prospects versus its peers. With top-line growth of 5.5 % between full-year 2021 and full-year 2022, perhaps the market is merely pricing in growth from IBM's already existing main revenue drivers (Consulting, Infrastructure, and Software). The more advanced research segment which includes quantum computing does not appear priced in.
The point in making here is that if IBM does succeed in developing a substantially profitable quantum computer to power next-generation AI, the market should ascribe a much higher P/E to the stock than it currently does - and potentially ascribe that higher P/E to a much higher earnings figure. The combination of growth in both actual earnings and the valuation ratio ascribed to those earnings is the recipe for classic " Fisher growth investing ". If IBM does succeed, the market likely should ascribe a P/E in the ~30 range like many of its fast-growing peers. And if the earnings are much higher then, I think you could easily see the stock trade above $300 as against the current ~$147.
The risks of quantum computing
I consider the main risk involved with IBM's ambitions in quantum computing - and thereby to a large extent the risk involved in considering IBM a growth stock - to be competition from other players in the field.
These include Google (Alphabet, NASDAQ: GOOG ). Google's latest iteration of its quantum machine, Sycamore , holds 70 qubits. Google themselves have said that developing quantum computers is a main area of focus, and makes this bold statement on their " Quantum AI " website:
Our goal is to build scalable quantum computers that enable humankind to solve problems that would otherwise be impossible.
Other players in the field are charging for first spot, too. These include IonQ (NYSE: IONQ ), a company's whose quantum technology differs somewhat from that of IBM. The company's quantum computer (Forte) is under development, and they are expecting to produce the first commercially viable results in the near future.
As previously noted, tech powerhouse Microsoft also wants to conquer the field of quantum computing. It recently released a video detailing its first milestone achievements towards that goal.
Whether or not IBM can sustain the challenge of competition remains to be seen. But it certainly has an edge in terms of qubits and willingness to pursue high ambitions in the field.
Key takeaways
IBM is thought of as a value stock because of its high yield, low P/E attributes. It's a legacy tech company that has existed for a very long time, and it used to be a hardware intensive company.
Now, though, IBM is in the process of transitioning their business. In doing so, one main area of focus for the future is quantum computing. The prospects of this field are exciting: If IBM succeeds in developing a commercially viable quantum computer, it could help power the next generation of AI tools and services. This would put IBM ahead of a game that is now lead by Nvidia in the sense that Nvidia powers much of this generation AI.
But in comparing IBM to Nvidia, a second point should be noted. Nvidia was founded in 1993, and it's taken three decades for their product line to fully demonstrate its capability. It could take just as long before we see the results of IBM's visions. But if they succeed, I so no way other than the market having to ascribe a much higher P/E to IBM than it currently does - and that makes IBM a stock you should look at through the lens of a growth investor.
For these reasons, I rate IBM a Buy.
For further details see:
IBM: Why This Industry Dinosaur Might Be The Next Nvidia