Although we don't believe in timing the market or panicking over daily movements, we do like to keep an eye on market changes -- just in case they're material to our investing thesis.
Between its heavy weighting on the Dow Jones Industrial Average (DJINDICES:^DJI) and its 2.1% gain this afternoon, IBM's (NYSE:IBM) stock is pulling the blue-chip index higher. As of 1:30 p.m. EDT the Dow is up 103 points, or 0.68%, to 15,294. The S&P 500 (SNPINDEX:^GSPC) is up a modest 0.2%, held back by tech behemoth Apple's steep decline.
IBM's stock is currently the largest component of the Dow Jones Industrial Average, accounting for 9.4% of the index -- this, despite the fact that IBM is nowhere near the largest Dow member by market capitalization: Its market cap of $208 billion is just more than half ExxonMobil's $390 billion market value. The second-heaviest Dow component is Chevron, accounting for 6.2% of the index.
This peculiarity is the result of the Dow's antiquated weighting system. The Dow is weighted solely by the stock prices of its 30 components. So IBM, with its stock price of $190, has nearly double the weight of ExxonMobil, priced at $89. This system made sense in 1896 when the Dow had to be calculated by hand, but it makes little sense now.
The absurdity of the index can be seen further in yesterday's announcement by the Dow Jones Averages Committee. The committee will replace the smallest of the Dow components by stock price -- Alcoa, Hewlett-Packard, and Bank of America -- with Goldman Sachs, Nike, and Visa. IBM's weighting in the Dow will drop, as Goldman Sachs and Visa have similar stock prices to IBM ($165 and $186, respectively, at the time of writing). This change is being made despite the fact that Bank of America is twice as large as Goldman Sachs and $30 billion larger than Visa.
While the media loves to report on the level of the Dow, largely because it has simply been around for so long, the financial community long ago shifted to following the S&P 500. The S&P 500 includes 500 stocks and is weighted by market cap so that the largest companies have an effect proportional to their size.
Dan Dzombak can be found on Twitter @DanDzombak or on his Facebook page, DanDzombak. He owns shares of Bank of America. The Motley Fool recommends Bank of America, Chevron, Goldman Sachs, Nike, and Visa. The Motley Fool owns shares of Bank of America, International Business Machines, Nike, and Visa. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.