What a Joke: Now Apple Joins the Dow Industrials

03/06/2015 5:37 pm EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

The change in the Dow—this tech behemoth in and this telecom out—continues the gradual reduction in the number of telecom companies and gradual increase in the technology component, and MoneyShow’s Jim Jubak points out the many reasons nothing about this should be viewed as merely a coincidence.

Just in case you needed a reminder of why the Dow Jones Industrial Average is a joke comes today’s headline: Apple (AAPL) will join the 30 stocks in the Dow Industrial index effective March 18. Apple will replace AT&T (T) in the index.

The change continues a gradual reduction in the number of telecommunications companies in the index. Verizon (VZ)—once a mainstay of the Dow—will be the only member of this group remaining with the departure of AT&T.

And it continues the gradual increase in the technology component of the index. With the addition of Apple, the Dow will include five technology companies: Apple, Microsoft (MSFT), IBM (IBM), Intel (INTC), and Cisco Systems (CSCO). The last change in the Dow Industrials before this occurred in September 2013 when the Dow Jones Averages Index Committee dropped Hewlett-Packard (HPQ), Alcoa (AA), and Bank of America (BAC) and replaced them with Goldman Sachs (GS), Visa (V), and Nike (NKE).

How does the index committee pick stocks for inclusion in the Dow Industrials? The guideline on the Dow Index site makes it clear that this is a subjective process. “While stock selection is not governed by quantitative rules, a stock typically is added only if the company has an excellent reputation, demonstrates sustained growth, and is of interest to a large number of investors. Maintaining adequate sector representation within the index is also a consideration in the selection process for the Dow Jones Industrial Average.”

I’d make the case that for the last, say, twenty years, the committee has been engaged in playing catch up with changes in the US economy. Out have come stocks such as Alcoa, International Paper, Union Carbide Goodyear, and General Motors. In have come Microsoft (1999), Intel (1999), Cisco Systems (2009), and Home Depot (1999).

That doesn’t totally explain all the adds and drops. In some sectors, the choices seem, well, like stock picking. Goldman Sachs and Visa in, but Citigroup and Bank of America out. Or like market timing. American International Group in in 2004 and then out in 2008. Citigroup out in 2009.

What the guidelines on the Dow Index site don’t make clear, though, is the influence that share prices have on index selection. Unlike the market capitalization-weighted Standard & Poor’s 500, the Dow Industrial Average is weighted by share price. A stock like Apple—when it sold at $700—gets a lot more weight in calculating the price and performance of the index than a stock like Apple when it sells at $130 a share. It’s certainly possible to make a case that Apple should be in the index because it is an iconic US stock, owned by everybody and their Aunt Sally, and representative of the character of the current US economy. But there’s also no doubt that Apple could have been in the index a year ago except that it traded at $700 a share. Apple didn’t make the index until after its 7-for-1 split in June 2014, because at $700, the shares would have simply had too much influence on the volatility of the index.

Google’s (GOOG) $600 share price (well, $567 today) is one reason this iconic, widely owned representative of the current US economy isn’t in the Dow Industrials.

And it’s not really a coincidence that Apple will join the Dow Industrials after the close on March 18 and that Visa, currently trading at $269, will split 4-for-1 effective March 19. The Visa split will leave Goldman Sachs—at $187 today—the most heavily weighted stock in the Dow Industrials.

Think about all this—and about the substitution of Apple, a very cheap growth stock, for AT&T, a lagging stock down 4.5% in 2015 to date—the next time you hear a talking head raving about Dow 18,000 or Dow 20,000.

Such speculation about when an index is going to meet some magic number doesn’t ever mean very much. For the Dow Industrials that talk means even less.

Think the new Dow with Apple just might outperform the old Dow with AT&T?

Just as importantly, so what if it does?

By the way, indexes based on the Dow Industrials account for only about $32.8 billion compared to the $1.9 trillion directly indexed to the S&P 500. So yes, the addition of Apple to the Dow Industrials will lead to some buying by index portfolios, but it won’t be a huge push for Apple shares.

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