Squawk Morning Briefing: Watch IBM Today

Today isn’t the first time we’ve talked about the importance of IBM when watching the DJIA and it probably won’t be the last. The reason is that the DJIA is a price-weighted index and the higher the price of a stock the more impact it will have on the index. IBM closed at $210.80 a share. That’s nearly double the $114.09 price tag for a share of CVX, its closest competitor. That means a 1% change in IBM will have nearly double the impact on the index as a 1% move in CVX. And it will have more than double the impact of everything else.

The reason we’re focusing on it today is that IBM reported Tuesday afternoon and, at the moment, seems poised for a big move down. That also means that it’s poised to have a significant impact in the DJIA. To see how much of an impact we’ll look at how the DJIA is constructed. When the index was first conceived it was pretty simple: 1) take a group of stocks; and 2) add all their prices together to get the value of the index. However, that posed problems when stocks in the index were replaced or when stocks would split. That led to the creation of an adjustment factor which is updated each time there is a change. The current “Dow divisor” is 0.130216081. So if you wanted to calculate the value of the DJIA just add all the components and divide by that number. We’re just going to estimate the impact of the IBM move so let’s approximate the impact and say that if you multiply by 7.7 you’ll get an approximate answer.

Pre-market, IBM is trading at 204 as of 6:27 EDT. That represents a $6.80 per share drop. If we multiply $6.80 x 7.7 we get $52.36. If IBM opens at this level then it will take more than 52 points out of the DJIA all by itself independent of the impact from other stocks. That’s why you can see such a dramatic drop in the Dow futures Tuesday afternoon when IBM reported. IBM is also a component of the S&P 500 but it doesn’t have such an outsized weight in that index so it didn’t move as much on the IBM news. Armed with the knowledge that IBM can have such a big impact on the index and with the knowledge that IBM is making big moves today, we know that we should be watching it to help gauge the direction of the DJIA.

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