Is IBM Still a Warren Buffett Stock?

What's been an entirely forgettable year for enterprise tech stalwart International Business Machines (IBM 1.05%) went from bad to worse recently when IBM delivered what can only be described as an entirely brutal earnings report.

Source: Wikimedia

Suffice to say, IBM shares took it on the chin in the wake of its subpar report.

One of IBM's saving graces and a staple of long-established bull theses on IBM has been the on-going support of one deservedly noteworthy investor, multibillionaire and Berkshire Hathaway (BRK.A -0.28%) (BRK.B -0.68%) CEO Warren Buffett. I'll be the first to admit that Buffett's track record is beyond reproach. However, in sifting through the rubble of IBM's abysmal quarterly report, I find myself asking if IBM still is a Warren Buffett stock. Let's take a look.

IBM: A broken investment thesis?
It's difficult to sift through IBM's most recent quarterly earnings announcement and not ask this question for several reasons.

By far the most important issue that gives me pause wasn't the diminutive business results specific to IBM's third quarter, although I'll certainly touch on those as well later. To me, the primary driver that potentially invalidates the merit of IBM's longer-term business prospects comes from IBM and CEO Ginni Rometty officially stating IBM will in fact not meet its years-old and often-repeated goal of achieving $20.00 in operating earnings-per-share (OEPS) for fiscal year 2015. Below you'll see IBM's revised OEPS estimates as they stand after its earnings shortfall.

Source: Bloomberg 

This seems like an appropriate enough point to fess up and wipe the egg off my face. I, like Warren Buffett, did not foresee such a drastic underperformance from IBM's overall businesses. In my earnings preview for Big Blue, I argued that IBM, as had been the case historically, would meet its OEPS pledge come hell or high water.

More importantly, this massive resetting of expectations for IBM points to a more drastic disruption to IBM core business, one that's powerful enough to rewrite the overall investment case for IBM. The reason? For the last several years, IBM's revenue has notably stagnated as enterprise tech has shifted away from IBM's wheelhouse of servers, which begat higher margin software and services contracts, toward cloud computing.

This shift hasn't gone undetected by the investing community. However, that same investing community was until recently tolerant of this risk factor so long as IBM signaled it would eventually stem its sales declines and also continued to buy back its shares en masse to keep EPS growth's upward trajectory. However, by amending its bottom line growth pledges, IBM has officially admitted that its current strategy has grown untenable. To paraphrase, the business reality has materially changed for IBM, and hence, the investing rationale also deserves reconsidering.

Why IBM will remain a Warren Buffett Stock anyway
Now, that being said, I'm also a firm believer that IBM will remain a Warren Buffett stock for a number of reasons.

The first is philosophical. Although he now tends to prefer purchasing great businesses at fair prices, Warren Buffett remains a long-term oriented value investor; it's part of why we Fool's admire him so much. In an era of continually shortening holding periods, Buffett rightly sees the stocks he owns as claims on businesses in whose long-term prospects he wishes to participate. A falling stock often signals opportunity over offense. Now, it's also worth noting that IBM's current stock price struggles actually magnifies the value creation of IBM's buybacks and could serve as a counterweight as it refashions its business. As stated above, I might contend this can only get an investor so far, but it's undeniable to an extent.

The other reason IBM will likely remain a Warren Buffett stock is pragmatic. With billions of capital to deploy, Buffett's investment opportunity set is unfortunately limited (insert golden handcuff or embarrassment of riches jokes here). However, it's a hard truth that Buffett's funds have grown so large that in the absence of something critically and permanently devastating to IBM's long-term business outlook, IBM will still remain a Warren Buffett stock.

Things are certainly bad at IBM, and I'm guessing Buffett failed to appreciate the magnitude and pace of the shift toward cloud computing and away from server-based storage. However, Buffett has made a fortune as a result of his willingness to buy into companies investors had left for dead (American Express during the Salad Oil crisis comes to mind). IBM has successfully reoriented its business in the past, and I'm guessing for the above reasons that Buffett will stick around long enough to find out whether it can do so once again. After all, Warren Buffett did famously advise, "Be fearful when others are greedy, and be greedy when others are fearful." Whether or not that applies to IBM remains to be seen.