Last week, Apple (AAPL) announced it would undergo a 4-for-1 stock split at the end of the month, a corporate action that will result in a major portfolio shake-up for one of the largest mega-cap ETFs on the market.
Apple will go from the largest holding in the $22.2 billion SPDR Dow Jones Industrial Average ETF Trust (DIA), at 11%, down to roughly the 16th largest weighting, with a weight of just 3%. Weights in the other stocks will rise accordingly.
The impact is so significant due to DIA's peculiar weighting methodology: Like its benchmark, the Dow Jones Industrial Average ("the Dow"), DIA weights its securities according to price. And Apple's price is about to drop, big-time.
How Price-Weighted DIA Works
Though the Dow is still widely tracked, price-weighting itself is rare in ETF land. DIA is one of just eight U.S.-listed ETFs to weight their securities by price, as opposed to market capitalization or various accounting fundamentals. In fact, all but two of the other price-weighted ETFs are Dow-linked (and the two that aren't are linked to the Dow's cousin, the Dow Jones Transportation Average Index):
|Ticker||Fund Name||AUM||Expense Ratio||3-Mo TR|
|DIA||SPDR Dow Jones Industrial Average ETF Trust||$22.50B||0.16%||10.09%|
|UDOW||ProShares UltraPro Dow30||$727.32M||0.95%||25.53%|
|SDOW||ProShares UltraPro Short Dow30||$664.20M||0.95%||-32.83%|
|IYT||iShares Transportation Average ETF||$617.50M||0.42%||14.58%|
|DOG||ProShares Short Dow30||$444.87M||0.95%||-10.96%|
|DDM||ProShares Ultra Dow30||$340.48M||0.95%||18.52%|
|DXD||ProShares UltraShort Dow30||$194.55M||0.95%||-22.10%|
|TPOR||Direxion Daily Transportation Bull 3X Shares||$30.32M||1.01%||39.62%|
Source: ETF.com. Data as of Aug. 4, 2020.
Price-weighting is so uncommon that many investors often struggle to understand how exactly it works. The Dow's index methodology is both simpler and more complex than it might at first appear.
The Dow's index value is calculated by adding together the individual trading prices of each constituent stock, then dividing by the "Dow divisor," a fluctuating factor designed to account for corporate actions and thus maintain the integrity of the valuations of the index's constituents.
Over the decades, the Dow divisor has changed considerably: When the index first began, it was 30 (making the Dow's index value a simple arithmetic mean), but today, it is just 0.1474.
As a result, the Dow's value now far exceeds just the mean of its components (even though it still has "average" in the name): For every $1 change in a constituent's price, the Dow moves 6.78 points.
Price-weighting makes the Dow—and DIA—particularly sensitive to corporate actions such as stock splits, where a company's trading price can change radically overnight. To some extent, the flexible nature of the Dow divisor is meant to accommodate for that—but mostly, it can only cushion the blow, rather than erase the impact altogether.
What's Inside DIA
Complicating matters is the nature of the Dow's security selection process. The index only holds 30 large-cap companies, which are selected at-will by a committee consisting of representatives from S&P Dow Jones Indices and Wall Street Journal. (Charles Dow, a former editor at the WSJ, first published the index in 1896.)
There's a lot of indexer discretion involved, which has led to a benchmark that has become more of an abstract concept than a mirror of the U.S. economy. The index doesn't include transportation or utilities stocks, which are covered by separate Dow Jones indexes; and the Dow excludes some of the biggest U.S. companies, including Alphabet (GOOGL), Amazon (AMZN), Berkshire Hathaway (BRK.B), Facebook (FB), and so on.
(Use our stock finder tool to find an ETF’s allocation to a certain stock.)
In fact, though tech stocks drive the majority of U.S. stock market returns, the Dow only has five tech stocks in it: Apple at 11%, Microsoft (MSFT) at 5%, Cisco (CSCO) at 1%, IBM (IBM) at 3%, and Intel (INTC) at 1%.
Of these five, Apple is by far the largest driver of performance.
What Happens In A Stock Split
Apple's stock split goes into effect Aug. 31. Typically, stock splits have more of a psychological effect than a trading one. When a stock splits, nothing changes about the security's fair value; all that changes is the number of shares on the market and their handle, or price.
In a 4-for-1 stock split, the number of outstanding shares increases by four, while the stock's price is divided by the same factor. Therefore, an investor holding one share of Apple, currently trading around $440/share, will find themselves after the split with four shares worth $110/share (assuming the price remains roughly the same, of course).
Stock splits usually occur because company bigwigs are bullish on the company's future, and they want to lower the price to attract more investors. (Compare that to reverse stock splits, which attempt to stanch the bleeding for a sharply descending security. Read: "What It Means When ETFs Reverse Split.")
But stock splits are less common than they used to be, and the advent of fractional share trading—where investors can purchase lower-cost slices of a stock, no matter how large its handle—has reduced the importance of "reasonable" trading prices for investors.
Apple No Longer Driving Performance
But trading prices do still matter in the Dow. As the holding with the largest price, and thus the largest weighting, Apple has been the engine of DIA's performance, rising 50% year-to-date through Aug. 4. (The next strongest performer is Microsoft (MSFT), up 36%.)
But when Apple's weighting changes due to its stock split, its strong year-to-date performance suddenly will be overwhelmed by that of less high-flying stocks that carry a bigger weight.
Starting in September, UnitedHealth (UNH) will likely become the DIA's largest holding at 9% (assuming today's price levels roughly hold until the end of the month).
As of Aug. 4, UnitedHealth was up just 4% for the year.
Bigger Performance Divergence Ahead
As the weights shift, we will likely see DIA's performance diverge even more widely from that of ETFs linked to other large-cap indexes.
Already DIA has lagged its market-cap-weighted cousins, including the SPDR S&P 500 ETF Trust (SPY), which is benchmarked to the S&P 500 Index; or the iShares Russell 1000 ETF (IWB), which is benchmarked to the Russell 1000 Index.
Year-to-date, DIA is down 6.1%, while SPY is up 2.5% and IWB is up 2.9%.
Given the changes ahead, investors would do well to remember that DIA is not a reflection of the U.S. large-cap space, and keep their expectations of the fund's future performance in check.
Contact Lara Crigger at [email protected]