Apple (AAPL 0.85%) has been conspicuously missing from the Dow Jones Industrial Average (^DJI 0.16%) for some time now, as it's been the first- or second-largest company by market cap since 2010. After its just-announced stock split, Apple could find itself becoming a member of the Dow. Read on to find out more, who it would likely replace, and what this means for you.
The Dow
The Dow Jones Industrial Average was created in 1896, and is the most widely quoted measure of the U.S. stock market. The goal of the index is "to provide a clear, straightforward view of the stock market and, by extension, the U.S. economy." While the Dow isn't the best measure of the level of the market, the Dow's members are supposed to be representative of the economy as a whole.
Membership in the Dow Jones is not rules-based, but determined by a committee of The Wall Street Journal's managing editor, the head of Dow Jones Indexes research, and the head of the CME Group research. CME Group bought a 90% stake in the Dow Jones indexes business from News Corp. in 2010.
The Dow is a price-weighted index of just 30 stocks, meaning it is weighted by the stock prices of its component companies and nothing else; companies with larger stock prices have proportionally larger effects. The fact that it is a price-weighted index is the reason Apple has not been included so far, as its $300+ stock price since 2010 would make it the Dow Jones' largest-weighted stock, by far. If it had been included back in 2009, the Dow would be far higher than it is now.
Apple news
Apple's large stock price will no longer be a problem, as yesterday, the company announced it would undergo a seven-for-one stock split on June 9. At today's closing price of $567.77, that means post-split you would get seven shares each trading for $81.11. This clears the way for Apple to be put into the Dow, and would put Apple's shares at 15th in terms of weighting -- assuming Cisco was taken out.
Making room?
Common sense suggests that, if a stock is removed to make way for Apple, it will be either Cisco or Intel. The two are the lowest-priced tech stocks out of the Dow's current five tech stocks. Both are also hardware companies; thus, either would be a like-for-like swap with Apple.
An interesting alternative, though, would be for Apple and a few other stocks to be added at the same time, expanding the Dow from its current 30 stocks. In a FAQ from CME Group that acknowledges the criticisms of the Dow Jones, CME group writes: "3. Have you considered changing The Dow to market-capitalization weighting? Yes, but not nearly as seriously as we thought about increasing the number of stocks." This wouldn't be the first time the Dow's size was increased.
In 1896, the Dow was originally an index of just 12 stocks. It was not until 1928 that the Dow was increased to 30 stocks. The Dow is weighted by the stock prices of its component companies and nothing else. To calculate, you simply add up the stock prices of the components and divide the total by the Dow Divisor. When the index was formed, the divisor was 12; but after 117 years of stock splits, dividend payments, and component changes, it currently stands at 0.15571590501117. If the number of stocks goes up, the divisor will have to be changed; but that's fairly simple.
If the Dow was increased to 40 or 50 stocks, Apple, as well as numerous other stocks, could be added to make the Dow Jones Industrial Average more representative of the economy.
The meaning for Apple's stock
So what does this mean for Apple stock? Not much. Apple being added to the Dow Jones may mean the stock may be talked about a bit more in recaps of the market, but there won't be any affect from more index funds investing in Apple.
The Dow Jones Industrial Average's price-weighted methodology and lack of clear rules of membership are two of the main reasons that there aren't many index funds that follow the Dow. The S&P 500 (^GSPC +0.80%) is the clear winner in this respect as its market capitalization methodology, giving larger companies proportionally larger weight, makes a lot more sense than a price-weighted methodology.
