By Paul R. La Monica

After years of watching the Magnificent Seven with envy, IBM investors no longer are singing the big blues. High expectations, however, could have them singing in a minor key again.

IBM stock, at $260.22, is up nearly 20% so far in 2025 and near a record high, making it the best performer in the Dow Jones Industrial Average. The company is finally being given credit for what it has become: an emerging leader in cloud computing and generative artificial-intelligence technology thanks to products and services like Granite and watsonx. That has helped fuel growth in its software and consulting services businesses -- and excitement for the stock.

The problem is that investors may now have unreasonable expectations. IBM is no longer being valued like a slow-growth old tech stock that often relied heavily on stock buybacks to boost earnings per share. Big Blue is now trading at about 24 times 2025 earnings estimates, a five-year high and well above its average forward price/earnings ratio of 15.4. The stock is also trading at a 7% premium to the S&P 500's multiple; it has typically fetched a nearly 30% discount to the market.

But IBM isn't expected to post Mag Seven-like levels of profit growth. Analysts are forecasting annual earnings-per-share increases of about 6% for this year and 2026 and about 7% for the next few years after that. That means that IBM is trading at 3.5 times its projected long-term growth rate, a richer price-to-earnings-growth ratio than Nvidia and Alphabet and even slightly higher than Amazon.com.

Wall Street is heavily divided on where IBM goes next. Half of the analysts that cover the stock have it rated a Buy, while the remaining 50% have either Hold or Sell opinions on the shares. That's a much more bearish view than is typical for a widely known large-cap stock. What's more, the consensus price target for IBM is $253.56, some 3% below its current price.

Analysts, even those who have a more skeptical view of IBM's stock, acknowledge that the company has momentum in software. But "execution for the remainder of the year needs to be flawless, with any incremental downside surprises in software likely to result in further multiple compression," according to Morgan Stanley analyst Erik Woodring.

In a report following IBM's earnings in late April, Woodring noted that "software growth now needs to accelerate in the face of an uncertain macro backdrop" to justify the stock's premium valuation. He has an Equal Weight rating on IBM and a target price of $233 -- nearly 11% lower than its current price.

IBM still has issues with its legacy hardware business, which includes mainframes and other infrastructure. Revenue for the infrastructure division accounted for 20% of IBM's total sales in the first quarter, but those sales fell 6%. "We think the company deserves a discount because of its exposure to hardware," said J.P. Morgan analyst Brian Essex in a report after IBM's first-quarter earnings. He has a Neutral rating on IBM and a $244 price target.

IBM's transition to a more dynamic software and services firm is admirable. But Big Blue is no longer being valued like the boring PC and server company it once was.

Let's hope it doesn't fall flat.

Write to Paul R. La Monica at paul.lamonica@barrons.com

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May 22, 2025 10:31 ET (14:31 GMT)

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