Why Apple is Too Rich For the Dow Jones Stocks Index

By: Money_Morning

David Zeiler writes: Assuming the Dow Jones Industrial Average represents the biggest, most influential companies in America, Apple Inc. (Nasdaq: AAPL) easily qualifies.

With its massive market cap, trend-setting products, and global brand recognition, it is easy to argue Apple belongs as much or more than any of the current tech companies in the index.

In fact, Apple has superseded all of them, particularly Hewlett-Packard Co. (NYSE: HPQ) and Microsoft Corp. (Nasdaq: MSFT).

Yet the Dow Jones has ignored Apple while letting far weaker companies like, Bank of America Corp. (NYSE: BAC)and Alcoa Inc. (NYSE: AA) remain.

So what gives?...

In a nutshell, Apple stock is too rich for the Dow Jones Industrial Average.

Because the Dow Jones is price-weighted, Apple's current $565 share price would simply overwhelm the index.

If included, Apple stock would account for about 25% of the Dow Jones. That's more than double the 11.5% of current leader International Business Machines Corp. (NYSE: IBM).

"It wouldn't be the Dow Jones Industrial Average," Nicholas Colas, chief market strategist at ConvergEx Group told the Associated Press. "It would be the Apple Plus Some Other Stuff Index."

In this case, a price move of just 5% in Apple stock could push the DJIA up - or down - about 200 points.

Looking at it another way, had Apple been added to the Dow Jones in 2009 instead of Cisco Systems Inc. (Nasdaq: CSCO), the Dow would now be over 15,000.

That's well above the Oct. 2007 record of 14,164 and 2,500 points higher than where it stands today.

With that kind of heft, it's no wonder the Dow has shunned Apple.

How the Dow Jones Industrial Average Works
But it's not just Apple. Other Dow candidates trade high in the triple digits as well.

Google Inc. (Nasdaq: GOOG) trades at about $600, Mastercard Inc. (NYSE: MA) at about $400, and Amazon.com Inc. (Nasdaq: AMZN) at over $200.

"A system that worked for over a century may need to be adapted to include higher-priced stocks," Howard Silverblatt, the senior index analyst at S&P, told Barron's. Silverblatt cautioned that such changes "would have to be functional, understandable and maintain the integrity of the index."

That's a sticky issue. When the Dow Jones Industrial Average was created in 1896, it was calculated simply by adding up the closing prices of the 12 component stocks and dividing by 12.

But as stocks were added, and stock splits caused changes in stock prices, a method was needed to ensure such changes would not affect the average.

The answer was the Dow Divisor.

It changes every time the index components change so that when the markets open the next day, the Dow reflects the previous day's close. While something of an anachronism, the Dow's price-weighting and use of the divisor are what makes it unique.

The keepers of the Dow index have no desire to fiddle with this time-honored formula just to accommodate Apple.

"It would be a methodological mess," John Prestbo, the executive director of the Dow Jones Indexes, told Barron's. "You'd have a 29½-stock index."

Prestbo said the Dow has a purpose larger than including every Wall Street darling.

"My job and that of the index committee is to administer the Dow so that it does its job of reflecting the stock market, not to get companies into the Dow that people want," Prestbo said.

Still, the Dow's price-weighting dilemma goes well beyond Apple.

It's already a problem with IBM, which has more than twice the influence (11.5%) of any other Dow component. Meanwhile, the lowest-priced stocks in the Dow Jones, like Bank of America and Alcoa Inc. have almost no impact at all--about half a percent each.

The combination of the DJIA's relatively small sampling of 30 companies and the anomalies of its price-weighted system is why most Wall Street professionals prefer indices like the S&P 500 to the DJIA.

Should Apple (Nasdaq: AAPL) Do a Stock Split?
Given that the Dow isn't likely to change for Apple, could Apple change for the Dow?

Assuming price is the only impediment, Apple could do a 5-to-1 or even a 10-to-1 stock split to get its price into Dow Jones-friendly territory.

But that doesn't seem to be in the cards, either.

Apple last split its shares in 2005. Despite its rapid rise in price, the company has shown no inclination for any kind of stock split.

Apple CEO Tim Cook has repeatedly dismissed the possibility of a stock split, saying in March that "there's very little support that it helps the stock."

And unfortunately for the Dow, Apple isn't alone in frowning upon stock splits. Only 12 companies announced splits last year, compared to 35 in 2005 and 100 in 1997.

With neither Apple nor the Dow's proprietors in an obliging mood, it looks like the DJIA will not be getting any Apple DNA any time soon.

"Everybody is in love with Apple because it keeps defying gravity," Prestbo said. "That doesn't mean the Dow isn't doing its job of reflecting the market. Apple certainly qualifies in every respect except one -- price."

Source :http://moneymorning.com/2012/05/30/why-apple-inc-nasdaq-aapl-is-too-rich-for-the-dow-jones/

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