SAN FRANCISCO (MarketWatch) — Has International Business Machines Corp. lost its status on Wall Street as an earnings machine?



That is the question investors are asking in the fallout of IBM’s IBM, -1.72% dismal third-quarter earnings last week, which included a $1 billion revenue miss. Those results — so far — shaved nearly 7% off its shares in the last few days, with IBM’s stock falling Thursday to its lowest level in two years.

The biggest cause of the revenue shortfall was IBM’s hardware business, which is suddenly seeing a faster decline, in particular in its high-end systems running IBM’s version of Unix. That decline was also exacerbated by a 40% drop in hardware sales in China, some of which was the result of an economic reform plan, and some due to execution.

Of course, most investors realize that IBM, with flat revenue of $105 billion last year, is no longer a growth company. But it has remained an investor favorite for the cash it returns to investors via its dividend (currently 95 cents a share), its consistent share buybacks, and double-digit earnings growth.

But the big drop in its hardware revenue was not the only disappointment. IBM only slightly exceeded Wall Street’s consensus earnings estimates in the quarter because of a lower-than-expected tax rate.

“IBM has badly missed not just revenue but profit two of the last three quarters, which is unusual,” said UBS analyst Steve Milunovich, in a note to clients. Milunovich downgraded IBM to neutral and trimmed estimates for 2014. He noted that while results could improve as 2014 unfolds, he believes the next two quarters “likely won’t be too encouraging.”

“The poor near-term results and question raised about farther out earnings power can’t be ignored,” he wrote late last week.

Chief Executive Virginia “Ginni” Rometty took quick action. In an internal email to employees that was reviewed last week by the Wall Street Journal, she voiced her concern that the company needs to ‘”do better.” “Ours is a pay-for-performance culture and we must all be committed to taking action to address our performance gaps,” Rometty wrote, according to the Journal.

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Rometty also made some executive changes and reassigned James Bramante, the senior vice president who was in charge of the company’s growth businesses, which included China.

IBM rival Hewlett-Packard Co. HPQ, -0.99% has been going through similar issues in its high-end hardware business. These businesses are being hurt as some corporations replace the expensive servers based on proprietary technology that run their businesses with lower cost servers built with off-the-shelf parts.

So while there are major industry trends going on, IBM’s miss on revenue was so hefty that some on the street are now debating whether there are issues at IBM itself. “One key question is whether IBM’s weakness is company specific or macro/industry related,” wrote Bernstein Research analyst Toni Sacconaghi, in a note, adding that IBM’s weak performance in software and the ostensible disruption in China are “somewhat incrementally worrisome for other enterprise players.”

Sacconaghi, though, does not believe the IBM earnings machine, or as he put it, its financial model, is broken. “Ultimately, we believe it is not, and that the deterioration of the company’s financial results is principally due to an imploding hardware business (and to a lesser degree a rapid change in the Japanese yen), which ultimately should be a much lower drag going forward,” he wrote.

Still, the tone on Wall Street has shifted, with some analysts skeptical that the company can achieve its long-standing forecast of $20 a share for 2015. Milunovich noted that “company credibility is at a low,” even though he believes that the 2015 earnings target is “attainable but no longer a simple feat.” According to FactSet Research, 55% of analysts have “hold“ ratings on the stock, up from 48% in the previous quarter.

Brian Marshall of ISI Group believes that IBM “needs to pursue bolder and larger” tech acquisitions, versus its previous strategy of buying smaller, lesser-known companies.



However she continues to resolve IBM’s issues, Rometty— who has been CEO since January 2012 — is going to be under some pressure. Investors will be watching to see what else she does to restore IBM’s credibility on Wall Street.