Apple In Dow Would Make DIA Even Weirder

Apple’s June share split puts the spotlight on the Dow’s antiquated price-weighting scheme.

The Dow Jones industrial average is probably the best-known index in the world. Quoted constantly in all forms of media, the Dow is practically unavoidable.

Yet Apple’s potential inclusion in the Dow highlights its well-known shortcomings.

The Dow uses a stock’s price—and only its stock price—to set the stocks proportional weight in the index. The index ignores whether the firm is large or small when its sets the weight.

In contrast, almost all other plain-vanilla indexes use market-cap weighting, which measures the firm’s true size in the market. Market-cap weighting uses share price too, but scaled by the number of shares outstanding.

Apple recently announced an unusual 7:1 stock split in June, ostensibly to make its massive share price more accessible to mom-and-pop investors—and possibly to smooth its entry to the venerable Dow. Getting the stock into the Dow would force all of the index-based products to buy more Apple stock, potentially boosting or at least supporting its price.

Before we assess AAPL’s likely weight in the Dow, here’s a graph of what the current Dow looks like relative to the same 30 stocks using market-cap weighting.

I’m using the large and liquid SPDR Dow Jones Industrial Average Trust ETF (DIA | A-74) as a proxy, with DIA’s current weights in dark blue and hypothetical market-cap weights in light blue. (Data: DIA holdings from ETF.com; hypothetical market-cap weights calculated by me from Bloomberg values.)

Firms like Visa and Goldman Sachs dominate DIA despite their much smaller market-cap. while huge firms like Exxon-Mobil and Microsoft take a backseat.

Oddest of all: Industrial giant GE gets a huge haircut despite this being an industrial index.

While smart-beta ETFs often differ from market-cap exposure, they do so with a purpose, such as a bias toward value stocks. Price-weighted indexes lack a justification for weighting, and are extremely sensitive to moves in share prices from stock splits.

Apple’s split would put its price at about $80. Here’s what a new Apple share would look like in a hypothetical DIA basket using price weighting, shown in gray, versus market cap weighting in light blue.

I arbitrarily removed P&G to make room in the 30-stock Dow for AAPL simply because P&G’s current price is closest to $80, but who knows which stock would get the boot?

Apple would be about 3 percent of DIA instead of the 10 percent that its huge market value of equity would command in a cap-weighted index.

Ironically, a much smaller 2:1 split instead of the 7:1 split would have brought AAPL’s hypothetical weight in DIA into line with its market cap. Note that the arbitrary size of the split directly affects the weight of Apple in the price-weighted Dow, while splits have no impact at all on market-cap-weighted indexes.

Again, price weighting just doesn’t make sense.

True, the Dow’s performance is highly correlated with major cap-weighted indexes like the S&P 500. But ETFs have helped make beta exposure so incredibly efficient that we argue over basis points of performance difference.

Meanwhile, the Dow lags our MSCI large cap benchmark index by some 5.5 percent over the past 12 months; sometimes, it leads, to be sure. The point is that it’s materially different from pure beta.

In all, I’m hard pressed to find any justification for allocating to Dow vehicles—including DIA, which does a great job delivering a lousy index—given the availability of far-superior beta products.

Including the world’s largest firm by market cap in the Dow makes should make it more representative; instead it just underscores its weirdness.

At the time this article was written, the author held no position in DIA but held all the underlying securities. Contact Paul Britt at [email protected] or follow him on Twitter @PaulBritt_ETF.