The generative artificial intelligence (AI) boom has launched a golden age for chip designer Nvidia (NASDAQ: NVDA) and its investors. Software and services veteran IBM (NYSE: IBM) also benefits from the same trend, but in a very different way.
Which one of these tech titans is the better AI stock in the summer of 2024? Let's take a look.
Nvidia's generative AI bonanza
Nvidia wasn't a very exciting story before the generative AI surge. Two years ago, the company tried its best to distance itself from cryptocurrency mining and the lockdown-boosted consumer interest in video gaming gear was fading out. Nvidia was already shipping tons of AI accelerator chips behind the scenes, but to limited fanfare because nobody had seen ChatGPT yet. If anything, Nvidia's involvement in self-driving vehicle systems looked like a promising growth catalyst back then.
Oh my, how times have changed.
It's common knowledge that ChatGPT's artificial brain was built around Nvidia chips, and the company quickly emerged as the go-to supplier of AI accelerator hardware. One 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, lucrative batches.
So Nvidia's sales soared 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% in the year-ago period and 45% the year before that.
As a result, Nvidia's earnings and cash flows are skyrocketing. So is the stock price. Nvidia investors have enjoyed a tenfold multiplication of their stakes from the two-year lows in October 2022.
The stock is obviously up for good reason, but the AI enthusiasm feels a bit overheated. Whether you look at price to sales, price to earnings, or price to free cash flows, Nvidia is trading well above its long-term valuation ratio averages.
Long story short, Nvidia looks overvalued despite its soaring financials. I'd be a buyer again if the stock took a dramatic dip, but I cashed in some of my Nvidia profits in the spring and it's no more than a "hold" idea right now.
How IBM's drastic strategy shift is paying off
Unlike Nvidia, Big Blue isn't a hardware provider these days. I mean, its unique 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.
Thanks to its exclusive focus on business-class customers, the market was a bit slow to give IBM credit for its AI prospects. Enterprise-scale clients must put new software tools through the wringer of performance, security, and integration tests while also seeking budget approvals from several layers of management. It takes time, but the resulting contracts tend to be robust and long-lived.
That's where the company stands today. Many testing processes and approvals have run their course and IBM is starting to generate serious sales from its AI solutions under the Watson banner.
In July's second-quarter report, IBM reported $2 billion in generative AI orders, up from zero a year ago as the underlying watsonx service was launched in the summer of 2023. Management raised their full-year software growth guidance from mid-single-digits to high-single-digits -- an impressive boost since more than 80% of IBM's software sales are tied to multi-year contracts. And CEO Arvind Krishna expects that growth rate to climb into double-digit territory in 2025 and beyond.
Big Blue's AI growth is more mellow 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 another animal. I'd much rather invest in the slower burn with longer-lasting consequences.
And then there's the valuation angle. Next to Nvidia's lofty 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'm still holding some of my old Nvidia shares but I'm not looking to buy more any time soon. New money is much more likely to go into my IBM position instead, as that tech titan still looks undervalued.
Wall Street is slow to forgive IBM for a decade-long strategy shift, though I'd argue that 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 out 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% lower 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 strategy shift starts to pay dividends, making it an attractive option for new investments.
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Anders Bylund has positions in International Business Machines and Nvidia. The Motley Fool has positions in and recommends Nvidia. The Motley Fool recommends International Business Machines. The Motley Fool has a disclosure policy.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.