Late to the Party Again: Apple Gets Added to the Dow

I want to address the addition of Apple to the Dow Jones Industrial Average, so we have to get a few things out of the way up front.

The venerable Dow isn’t really all that important. It began life on May 26, 1896, but in the last 30 or so years, it has faded in significance. It remains deeply flawed in its methodology, driven rather arbitrarily by the price weightings of its constituents rather than their market values.

You can see how this affects the weighting of each component in the index. Companies with higher stock prices such as Visa and Goldman Sachs have a 9.7 percent and 6.7 percent weight, respectively, while lower-priced stocks such as Cisco Systems and General Electric are merely 1.05 percent 0.91 percent, respectively. Why Goldman Sachs, with an $84 billion capitalization, matters more to the Dow than General Electric, with a $257 billion capitalization, is rather mystifying. A high-priced, smaller company carrying more weight than a lower-priced, bigger company makes no sense.

Not only that, but it is an actively selected — though not actively traded — portfolio, managed by a group of editors. Originally these editors were employees of Dow Jones, the company, but since 2012 the index has been 73 percent owned by McGraw Hill Financial. The CME group, which had purchased the index from Dow Jones in 2010, owns 24.4 percent; Dow Jones retains the remaining 2.6 percent stake.

I can’t think of these strange bedfellows now in charge of selecting Dow components without being reminded that a camel is a horse that was designed by a committee.

What qualifies a company to be included in the Dow? According to theDJ Index fact sheet, 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.” (The full history of additions and deletions can be seen here). But that description is so broad as to be almost useless. There are hundreds of companies with those qualifications.

Why Apple, and perhaps more importantly, why now?

The problem is mostly revealed in the name of the index — the Dow Jones Industrial Average. As the history of the index reveals, the editors do fine with manufacturers, but they seem to have a problem with technology and telecom — which look and act decidedly unlike traditional big iron companies. Looking at some recent additions and deletions, it is clear that technology companies are not the forte of the index’s editors.

Consider:

• Microsoft entered the Dow on Nov. 1, 1999, at about $46 dollars. More than 15 years later, its stock price is about 10 percent lower.

• Intel was almost $39 when it entered the index the same day as Microsoft. At just over $32, it now is about 20 percent below its entry price.

• Cisco replaced General Motors on June 8, 2009, (GM had filed for Chapter 11 bankruptcy reorganization a week earlier) at about $20. It has gained about 48 percent since then, less than half the gain of the Standard & Poor’s 500 Index’s 123 percent rise.

• Verizon, added on April 8, 2004, is up 47 percent, but it still lags the broader indexes as well.

• Hewlett Packard was added on March 17, 1997, and removed on Sept. 23, 2013 and was little unchanged during that period. It is up 55 percent since being removed compared with 13 percent for the S&P 500 during the same period.

• It isn’t only technology companies that are so troublesome for the Dow. American International Group was added on April 8, 2004, and a little more than five years later was destroyed by bad derivatives bets, and required a government bail out.

(All returns are split-adjusted but don’t include dividends.)

Now we see Apple, having one of the most epic runs of all time, becoming the biggest company in the world, and only NOW does it get added to the Dow? After it created, reinvented or disrupted numerous industries? AFTER the iPod, iPhone, iPad? After Apple destroyed so many companies (Dell, Research in Motion, Nokia, etc.) along the way?

During the 16 years since Microsoft and Intel were added — while their prices went nowhere — Apple has gained roughly 4,500 percent.

Note that I am not saying Apple’s stock can’t rise, or that the iWatch isn’t going to be a hit, or anything like that. I have no idea about any of those things.

However, based on their track record, the editors in charge of selecting Dow components don’t really seem to have a firm grasp on what stocks are worth watching or are reflective of the state of U.S. financial markets and the economy.  That’s why investors pay less and less attention to the Dow index.

Originally:  Apple Is a Lagging Dow Indicator