The Giant Awakens
In this edition of the Smart Investor newsletter, we examine the stock of a technology giant that in many ways created the IT industry as we know it. But first, let’s dive into the latest Portfolio news and updates.
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Portfolio Updates
❖ Alphabet (GOOGL) is collaborating with Nvidia on quantum AI processors. The Google Quantum AI division, which focuses on advancing quantum computing technology, leverages Nvidia’s Eos supercomputer and Google’s hybrid quantum-classical computing platform to simulate the physics of quantum processors.
The Eos is one of the world’s most powerful AI supercomputers, specifically designed for large-scale high-performance computing (HPC) and AI workloads. It integrates Nvidia’s CUDA-Q, a software platform designed to enable quantum computing simulations on GPUs. By utilizing this platform, Google can run “noisy simulations” of quantum chip designs dramatically faster—i.e. minutes instead of weeks—reducing the time and cost of simulating quantum processors.
Beyond that, the collaboration allows Google to explore scalable architectures, prototype at scale, develop and refine cutting-edge designs, and more, which strengthen the company’s leadership in quantum computing. For Nvidia, this cooperation presents an opportunity to expand its involvement in the revolutionary technological field, preemptively building expertise and embedding itself in quantum development workflows.
In other company news, the U.S. Justice Department, within its antitrust push, is reportedly planning to ask the federal judge Amit Mehta, who in ruled in August that Google illegally monopolized the search market, to force Alphabet Inc.’s Google to sell off its Chrome browser. However, according to analysts and lawyers, there is little chance of the breakup actually taking place due to a lack of legal precedent as well as an absence of a suitable buyer. In addition, with the upcoming political change, every lengthy antitrust process is now mired in total uncertainty.
In yet another news, the U.K. Competition and Markets Authority (the antitrust agency) closed its inquiry into Alphabet’s investment in AI startup Anthropic, stating that it does not meet the criteria for material influence or revenue threshold. Alphabet-owned Google announced late last year that it plans to raise its investment in Anthropic to up to $2 billion. Investment in the startup, which offers a GenAI assistant Claude that has been gaining in popularity in recent months, presents an opportunity for Google to gain an edge in the AI competition over Microsoft with its OpenAI partnership.
❖ Dell Technologies (DELL) saw its stock jump after several Wall Street brokerages, including Mizuho Securities, Wells Fargo, Morgan Stanley, and others, raised their price targets on the stock due to growing opportunities in the AI server market. Dell is poised to benefit as increased availability of Nvidia GPUs allows it to produce and sell more AI-capable servers. In addition, AI hardware and infrastructure spending is on the rise among Tier 2 cloud providers, corporate clients, and governments and national institutions. Analysts predict that Dell will gain a larger share of the rapidly growing market.
In other company news, Dell announced AI Factory advancements. The Dell AI Factory is an integrated platform, which combines advanced infrastructure, software, and services to support organizations in developing, deploying, and scaling AI applications effectively. Recently, the company expanded the AI Factory with new high-powered servers and dense racks to offer support for Nvidia’s latest GPUs. The enhancements to Dell’s platform include new hardware offering industry-leading GPU density, as well as turnkey factory integration with liquid cooling or air-cooled options, among others.
❖ Verizon (VZ) is set to become even larger. The communications giant’s bid to acquire Frontier Communications was accepted by the latter’s shareholders and is now awaiting regulatory approval. The transaction is expected to notably expand Verizon’s fiber network, placing it on par with its major competitors, and facilitate the company’s return to California, Texas and Florida, markets it had previously exited almost a decade ago.
❖ Taiwan Semiconductor Manufacturing (TSM) received a final approval from the Biden administration for a $6.6 billion in funding for its Arizona plant under the CHIPS and Science Act. The funds will be disbursed in stages and TSM is expected to receive at least $1B by the end of 2024. In addition, the U.S. government also approved up to $5 billion in low-cost government loans to the chip foundry giant.
❖ Nice Ltd. (NICE) reported another set of strong quarterly results, exceeding estimates on all reported metrics. In Q3, total revenues grew by 15% year-on-year, operating income jumped by 20%, and EPS surged by 27%, operating margins expanded, and operating cash flow surged by 32% year-on-year. Recurring revenues now comprise 90% of the company’s total top line income, with cloud ARR reaching $2 billion. NICE maintained its full-year revenue guidance with expectations of a 15% growth at the midpoint compared to the previous year. At the same time, it raised its EPS growth forecast for 2024, now penciling in 26% growth at the midpoint compared to full-year 2023.
The Q3 report highlighted a 24% year-over-year growth in cloud revenue, reaching over $500 million. While substantial, cloud growth fell short of some analysts’ expectations. In addition, Nice adjusted its full-year organic cloud growth guidance slightly downwards due a shift toward larger, more complex enterprise deals that have longer implementation times, delaying revenue recognition. As a result, Piper Sandler analysts downgraded Nice from “Buy” to “Hold”, leading to a drop in the company’s shares. However, other leading Wall Street brokerages remain optimistic on the stock, with the average price target implying an upside of almost 48% in the next 12 months.
❖ Intuit (INTU) suffered a sell-off on Tuesday due to a media report about the new administration’s plans to create a mobile tax filing app. According to Jeffries analysts, such a negative market reaction is unwarranted. The analysts believe that developing such app is unlikely to be a high priority for the IRS, particularly in light of its failed the attempt at direct online tax filing, which achieved minimal adoption. In addition, Intuit primarily earns revenue from complex, paying tax filers, rather than from individuals with simple tax returns who typically use free or low-cost filing options. Jefferies kept its “Buy” rating on Intuit stock with a PT implying about 22.5% upside.
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Portfolio Stocks Under Review
❖ Applied Materials (AMAT) saw its stock drop after it released its fiscal Q4 and full-year results. In FQ4, the chip equipment maker topped revenue and EPS expectations, with top line growth of 5% year-on-year and an EPS increase of 9.4%. Quarterly revenue reached a record, underpinned by AI demand. In the full fiscal year, AMAT achieved record revenue and EPS, marking 2% and 7% year-over-year growth, respectively, and slightly exceeding analyst expectations.
Looking ahead, Applied Materials expects continued growth in the first quarter of fiscal 2025, guiding for above-consensus quarterly EPS. However, FQ1 revenue guidance disappointed, falling below analyst expectations. Analysts were concerned about AMAT’s business performance in areas that are not directly tied to AI. The company’s Foundry Logic segment growth was driven by AI-related demand, while some of its other business lines showed sluggish performance.
Applied Materials supplies equipment for manufacturing chips across all process nodes, including trailing edge, i.e. older semiconductor manufacturing technologies and process nodes that are less advanced compared to the leading edge. While AMAT’s latest report underscore persisting robust demand for trailing edge offerings, it may not be sustainable, specifically in automotive and consumer electronics areas.
The question of trailing edge offerings also comes to the forefront in relation to AMAT’s sales to China. The company’s exposure to the Asian giant – which, although declining, still stands at 30% of revenue – remains its biggest point of concern. The concern is two-faceted and relates to both Chinese demand and export restrictions. While AMAT’s sales in the U.S. surged by over 43% during FQ4, sales in China dropped by almost 28% year-on-year.
Weakening outlook for Chinese demand was the main factor behind a tepid FQ1 revenue guidance. Moreover, additional restrictions on sales to China could disproportionately impact trailing edge chip production, as the leading edge tech is already under government constraints. However, AMAT has been taking proactive steps to reduce its reliance on China following a strategic decision to mitigate risks associated with the geopolitical tensions and trade restrictions.
Applied Materials is a stalwart in its market, specifically in materials engineering, wielding a significant market share and technology leadership. It is well-positioned to capitalize on surging demand for AI and energy-efficient computing. Although lower Chinese sales, trouble at Intel (one of AMAT’s customers), and continued weakness in areas not related to AI and HPC may dampen the company’s fiscal 2025 sales outlook, they reflect a more muted industry environment rather than pointing at company-specific problems. Moreover, most analysts are optimistic regarding semiconductor equipment market’s growth going forward, which supports their “Buy” rating for AMAT.
Though several analysts have reduced their price targets on Applied Materials, the average price target still implies an upside of more than 31% for the stock in the next 12 months. Moreover, Goldman Sachs analysts raised their PT, saying that they “believe the company is well-positioned to benefit from the various technology inflections” that will drive the semiconductor industry forward in 2025 and beyond. These include next-generation transistor architectures, chip-performance enhancements through optimized power delivery, advanced packaging technologies, and more. AMAT is expected to benefit from increased investments in cutting-edge manufacturing technologies for both logic processors and memory chips.
Taking into account the continued short-term headwinds on one hand and AMAT’s strong market position, technological edge, and the ability to capitalize on future semiconductor advancements on the other, we are leaving the stock under review until any major news that could help us decide whether to retain the company in the Portfolio.
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❖ Adobe (ADBE) remains under review, where it was placed following its stock underperformance after underwhelming FQ4 guidance. Despite reporting strong FQ3 results that beat analyst expectations, ADBE’s investors were concerned about signs of decelerating growth. There were also worries about Adobe’s competitiveness in the rapidly evolving AI-powered software market. While Adobe remains a leader in its field with strong financials, these factors combined to create uncertainty about its near-term growth prospects.
However, we began observing a positive trend after the company’s annual Adobe Max conference on October 14th, which was rife with exciting news that created tailwinds for the stock’s rebound. ADBE made several major announcements, highlighting significant advancements across Adobe’s Creative Cloud suite, including the launch of over a hundred new features. Putting a strong emphasis on AI-powered products, the company unveiled new AI-enhanced tools in Illustrator and InDesign, updates to the Substance 3D content creation tool, and a beta version of a new web-based app for in-browser creation and editing of 3D content.
In addition, Adobe introduced significant updates enabled by its highly successful AI model, Adobe Firefly, which has already gained widespread adoption. The most notable development was the launch of Firefly Video, a new AI video-generation tool, which confirmed Adobe’s capability to pose strong competition to other generative AI tool providers. Adobe’s generative video AI is differentiated by its integration into its creative tool suite, which is expected to enhance user retention and platform consolidation, increasing product stickiness and revenue growth.
Additional positive development came this week, as ADBE announced a new AI-infused tool set for editing stock photos from its image library. As with its other AI-backed tools and solutions, the company ensures commercial safety and fair usage (i.e., that its models are trained on data to which ADBE has commercial rights, and that the original creators receive compensation).
Analysts are in disagreement regarding Adobe’s prospects vis-à-vis the AI boom. On the one hand, the growing abundance of free or inexpensive creative tools threatens to weigh on demand for its products. On the other hand, these tools are suited for beginner-level designs and present no competition to ADBE’s professional offerings, especially given that the latter are integrated into the company’s creative ecosystem. On the whole, most analysts believe that Adobe would be a net beneficiary of the AI advancements, enhancing – rather than endangering – its business model.
Adobe’s approach to add useful AI features to its most popular offerings is viewed by analysts as a path to fortify Adobe’s market position while streamlining its AI monetization process. Wall Street brokerages rate ADBE as a “Buy,” with an average price target implying a ~24% upside in the next 12 months. According to Goldman Sachs, Bank of America, and others, Generative AI tools will be a meaningful component to Adobe’s revenue growth. However, the jury is still out on ADBE, and these assumptions will be put to the test on December 11th, when ADBE reports its FQ4 earnings.
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Portfolio Earnings and Dividend Calendar
❖ The Q3 2024 earnings season is winding down, but several Smart Portfolio holdings are still scheduled to release their quarterly results in the next few weeks. This week, we are expected to receive the quarterly results of Intuit (INTU) and Dell Technologies (DELL).
❖ The ex-dividend date for Applied Materials (AMAT) and Microsoft (MSFT) is November 21st.
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New Buy: International Business Machines Corporation (IBM)
The International Business Machines Corporation, IBM, aka Big Blue, is a technology and IT consulting company. IBM provides integrated solutions and services worldwide. The company offers application, technology consulting and support, process design and operations, cloud, digital workplace, and network services, as well as business resiliency, strategy, design, and financing solutions.
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Incarnation of IT History
Founded in 1911, IBM in many ways originated the IT industry, which didn’t exist before the company began delivering its groundbreaking innovations. These included the ATM, RAM, magnetic storage technology, Fortran and SQL, the UPC barcode, the PC, networking protocols, and more. IBM helped to launch the first Apollo mission to the Moon, while its “thinking machine” Deep Blue was the first step towards today’s Artificial Intelligence (AI) technology. The company holds a U.S. record for the most patents generated by a single business.
Beyond its role as an IT powerhouse, IBM occupies a central stage in global financial transactions and telecommunications. The company’s mainframe computers, IBM Z, handle approximately 87% of all credit card transactions worldwide, as almost all leading banks around the world use these machines. Incredibly, IBM’s machines are responsible for providing half of all wireless connections in the world. In every way, the company’s computer systems serve as one of the pillars supporting the global economy.
With a market cap of over $190 billion and annual revenues of $62 billion, IBM ranks #63 on the Fortune 500 list of the largest U.S. firms. It operates in 175 countries, serving clients across various industries. The company’s customers include 95% of the Fortune 500 firms. The company’s stock has been traded on the NYSE since 1916, making it the second-longest listed technology stock after General Electric.
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B2B Powerhouse With AI Drive
Despite its lingering perception as a research powerhouse with weak business capabilities, IBM has been rapidly modernizing its business. After spinning off its legacy business of managed infrastructure services, IBM has been focusing on higher-margin, faster-growing areas. Today, software (particularly hybrid cloud platforms) and consulting account for 75% of total revenues, with over half being recurring. This lends IBM’s revenue streams high predictability and stability. To position itself for growth, IBM has acquired numerous firms in hybrid cloud, IT automation, and data analytics.
AI is a key growth area for IBM. The company has developed an extensive suite of AI tools, with its platform, watsonx, providing access to AI-as-a-Service for businesses. watsonx platform is designed to facilitate the development, deployment, and governance of AI models across various business applications. It offers a suite of integrated tools and services, such as watsonx.ai, a studio providing tools for building and fine-tuning GenAI and ML models; watsonx.data, a data store optimized for AI workloads, enabling efficient data access and management; and watsonx.governance, a toolkit designed to assist organizations in managing AI risks and compliance. IBM’s comprehensive and hyper-integrated ecosystem of platforms, software, and consultancy provides unique support that allow its business clients to transform their corporate operations.
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Collaborating For Success
IBM’s extensive partnerships with major public cloud providers and SaaS leaders, including Amazon’s AWS, Adobe, Cisco, Microsoft, Oracle, Salesforce, SAP, and Meta, have further strengthened its offerings. IBM’s recent integration of Meta’s Llama 2 AI model enhances its platform’s AI capabilities. These partnerships not only help IBM avoid direct competition with other major cloud providers but also drive growing consulting revenues.
In November 2024, IBM announced a collaboration with Advanced Micro Devices aimed at boosting performance and efficiency for generative AI models. Starting mid-2025, IBM will offer AI acceleration as a service on its cloud using AMD’s advanced Instinct MI300X accelerators. AMD’s accelerators are optimized for large-scale generative AI applications and HPC workloads. The cooperation is expected to further enhance IBM’s cloud and AI offerings, allowing it to attract additional enterprise customers, as well as strengthens its watsonx platform and position IBM as a leading AI infrastructure provider.
According to media reports, IBM has secured another major collaboration involving Amazon (AMZN) and Nvidia. The half-a-billion-dollar deal is centered around AI training infrastructure and technology integration. The agreement will enable IBM to access AWS’s EC2 servers equipped with Nvidia’s GPUs. IBM will use AWS’s servers to expand its AI capabilities, integrating the powerful computational resources provided by Nvidia GPUs into its AI training workflows. Earlier, IBM announced its plan to integrate watsonx with AWS’s ML platform. The new deal deepens the relationship between the two companies, enabling them to jointly offer generative AI solutions.
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Investing in Transformation
Over the past several years, IBM has pursued significant acquisitions to enhance its capabilities and market position, such as the buyout of Red Hat in 2019. In addition to strategic acquisitions, IBM has invested heavily in cutting-edge technologies such as AI, cloud computing, and hybrid cloud solutions. These developments have transformed IBM from a “boring” IT infrastructure behemoth into an agile giant, with revenues from software and consulting services comprising over 70% of total top line income. Moreover, IBM’s software segment is responsible for over 40% of revenue. With around 80% of software revenue being recurring, this lends IBM a great degree of revenue visibility.
While IBM’s growth strategies have contributed to its transformation, they have also resulted in elevated debt levels. Although IBM has been actively managing its debt post-Red Hat acquisition and its debt-to-equity ratio has improved in recent years, it remains high. However, credit-rating agencies are unphased, seeing very little risk associated with the company’s liabilities, which is reflected in IBM’s high credit ratings: “A-” at S&P and Fitch, and “A3” at Moody’s.
Fitch has praised IBM’s resilient operating profile and its focus on hybrid cloud and AI technologies and services, which has placed the company in a strong position to capitalize on the ongoing digital transformation, particularly the exponentially growing demand for data analytics and AI. The tech giant has reshaped its business model around these growth areas, which are expected to further drive growth. Its market share acquisition trend is supported by IBM’s deep and broad expertise in AI development and application.
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Ambitions Unleashed
The strategic emphasis on AI and cloud services has been a catalyst for IBM’s resurgence, reflected in its financial performance in the recent quarters. Thus, the company succeeded in transitioning from stagnating or even declining revenues in the past decade to top line growth in the past three years. Over that period, its earnings-per-share growth also regained altitude.
In Q3 2024, IBM confirmed its return to growth, producing solid results and issuing positive guidance for revenue growth in its key focus areas, software and AI. While revenue came in a tad below expectations, its EPS delivered a significant beat. Besides, IBM’s cash-generation abilities are recently back in focus. The company closed 2023 with a free cash flow growth of 41% year-over-year, with that growth slated to continue this year, highlighting its operational efficiency.
IBM’s aggressive push into high-growth areas is expected to further lift its already strong profitability and capital efficiency metrics and expand its enviable margins. Beyond the ongoing quarter, many analysts see significant tailwinds that should help it accelerate earnings growth, such as continued surge in enterprise AI demand, and recovery in customers’ consulting and infrastructure capex. In addition, the next occupant of the White House is expected to embrace a less restrictive regulatory approach towards M&A, which would benefit deal-hungry tech giants like IBM.
Recently, IBM was included in Evercore ISI’s list of Top Tech Picks for 2025. Evercore’s analysts anticipate that IBM could surpass growth estimates due to strengthening AI momentum and a favorable regulatory environment.
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Total Return In Focus
IBM’s stock returned over 36% in the past 12 months, strongly surpassing the S&P 500. Notably, this strong performance includes a decline of about 10% from its October all-time high, as the stock fell on profit-taking, some disappointment with Q3 revenue results, and general market anxiety.
However, the drop from the peak has led the stock to lower valuations, creating an attractive entry point for long-term investors. IBM is currently trading at par with the average Technology sector valuations and comes at the bottom of the scale for comparable peers. Moreover, based on future cash flows, IBM is undervalued by about 35%.
In addition to stock price appreciation potential, IBM rewards its investors with dividends. The company began paying dividends over a century ago in 1916 and has delivered uninterrupted payouts to shareholders ever since, which grants it a status of one of the most reliable dividend payers on the market. Moreover, the firm is a Dividend Aristocrat, featuring 29 years of consistent dividend increases. Its current dividend yield stands at 3.5%, almost fivefold the tech sector’s average.
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Investing Takeaway
IBM, a global leader in hybrid cloud and AI-driven solutions, continues to redefine its role in the technology landscape through strategic innovation and transformation. With a focus on high-margin recurring revenues from software and consulting, IBM leverages its AI platform and strategic collaborations to drive enterprise adoption of generative AI and cloud technologies. Its unparalleled expertise positions it to capitalize on the surging demand for AI and high-performance computing. The company’s operational efficiency, highlighted by strong cash flow generation and disciplined debt management, reinforces its financial stability and shareholder focus. Supported by an expanding portfolio, resilient margins, and a growing role in the global digital transformation, IBM presents a compelling investment opportunity for long-term growth, and as such, we view it as a valuable addition to the Smart Investor Portfolio.
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New Sell: Check Point (CHKP)
Check Point Software Technologies Ltd. is an American-Israeli multinational provider of software and combined hardware and software products for IT security, including network security, endpoint security, cloud security, mobile security, data security, IoT security, and security management. The company provides cyber security solutions to corporate enterprises and governments globally.
Check Point is the world’s largest pure-play IT security company with a 30% share of the global security software market. It boasts stellar financial health with zero debt and sizable cash pile on its balance sheet. Its capital efficiency and profitability metrics are outstanding. The only ingredient missing from the rosy picture is significant growth.
In the past five years, CHKP’s revenues grew at a CAGR of 5% and its EPS increased at a CAGR of 7.4%. Intense market competition makes it challenging for Check Point to significantly expand its market share. In addition, the company has encountered challenges in its go-to-market strategies, which have affected its capacity to effectively reach and engage potential customers. Despite substantial investment in product updates and the introduction of new offerings, the adoption rate has been gradual, delaying revenue realization. While some analysts previously said that the integration of AI into CHKP’s product suite would drive double-digit growth, it appears that this is taking longer than investors had hoped. Given the company’s apparent modest growth trajectory, several leading brokerages cut their ratings and price targets on the stock. TipRanks’-rated top Wall Street analysts now rate Check Point a “Hold,” with the average price target implying an upside of about 16% in the next 12 months.
A cybersecurity veteran, Check Point has long served as a “safe harbor” among technology companies, with low but steady and constant revenue and earnings increases through the years. However, the Smart Investor Portfolio now contains several stable low-beta stocks, negating the necessity to hold on to CHKP. We plan to revisit this fundamentally healthy cybersecurity leader when we see a clear path to more substantial long-term growth, but for now, we believe it is time to cash out on the gains.
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Smart Investor’s Winners Club
The 30% Winners Club includes stocks from the Smart Investor Portfolio that have risen at least 30% since their purchase dates.
After AMAT fell down through the 30% threshold, our exclusive club lists 18 stocks: GE, AVGO, ANET, EME, TPL, ORCL, TSM, HWM, PH, APH, IBKR, ITT, PNR, KKR, GD, CHKP, PYPL, and CRM.
The first contender is now AMAT with 23.97% gain since purchase, followed by DELL with a 18.53% increase. Will one of them close the gap, or will another stock outrun them to the finish line?
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Disclaimer
The information contained in this article represents the views and opinions of the writer only, and not the views or opinions of TipRanks or its affiliates and should be considered for informational purposes only. TipRanks makes no warranties about the completeness, accuracy, or reliability of such information. Nothing in this article should be taken as a recommendation or solicitation to purchase or sell securities. Nothing in the article constitutes legal, professional, investment and/or financial advice and/or takes into account the specific needs and/or requirements of an individual, nor does any information in the article constitute a comprehensive or complete statement of the matters or subject discussed therein. TipRanks and its affiliates disclaim all liability or responsibility with respect to the content of the article, and any action taken upon the information in the article is at your own and sole risk. The link to this article does not constitute an endorsement or recommendation by TipRanks or its affiliates. Past performance is not indicative of future results, prices, or performance.
