Apple is going to be added to the Dow Jones Industrial Average, effective March 19, S&P Dow Jones Indices announced Friday.
Adding Apple to the Dow is an obvious and overdue move if the index really is supposed to be a barometer of the 30 most-important American companies. It's also a move that reinforces why professional investors pay far more attention to the S&P 500 vs. the Dow, which most Americans (and most journalists) think of when they refer to "the market."
First, the Dow is price-weighted, which is an odd configuration for any index. One reason Apple wasn't in the Dow previously is that before its 7-to-1 stock split last June, it was viewed as being "too expensive." Pre-split, Apple shares would now be trading close to $900, which would have given the company far too big a weighting in the index. As it stands now, Apple would only be the sixth-most expensive stock in the Dow 30 behind Visa, Goldman Sachs, IBM, 3M and Boeing, Marketwatch reports. Again, Apple is by far the largest public company in America but it's only the "sixth-most" important in the Dow, based on its price.
Further adding to the oddity of all this: the stated reason why Apple is being added to the index now is that Visa stock is splitting 4-for-1 on March 18, which will "reduce the weighting of the Information Technology sector in the index," according to a press release from S&P Dow Jones Indices -- which categorizes Visa as an IT vs. a finance company.
"Moreover, the DJIA is over-weighted in telecommunications and AT&T and Verizon are quite similar, though AT&T has a smaller market capitalization,” David M. Blitzer, Managing Director and Chairman of the Index Committee at S&P Dow Jones Indices said in the press release.
How small is it? At roughly $174 billion, AT&T's market cap is smaller than Apple's cash horde, one of the many eye-opening statistics being tossed around Friday in the wake of this latest change to the Dow's makeup. In addition to being price-weighted, the somewhat arbitrary nature of changes to the Dow is another big reason why the pros focus most of their attention on the S&P 500 vs. the DJIA. (Hint: So should you.)
Keep this in mind the next time the Dow hits a record. People sometimes talk about "inflation-adjusted" records but the composition of the index matters most of all. The Dow would have been 450 points higher last Friday had Apple replaced IBM after the split last June and would have gained 9.8% vs. 7.1% since then, Reuters reported earlier this week. (If nothing else, today's decision will finally put an end to the "Why Isn't Apple in the Dow?" and "When Will Apple Be Added to the Dow" memes.)
Another stat/factoid being tossed about for your consideration: Companies added to the Dow outperform the S&P 500 by 3% in the 30 days after the announcement, according to Bernstein Research.
But that outperformance tends to be short-lived. There is a “clear pattern” of good performance leading up to the addition then “bad performance following,” Jason Goepfert, president of Sundial Capital Research, tells Marketwatch.
Goepfert examined the 20 days before and after an addition but recent history suggests the index tends to add stocks when they're peaking, and occasionally before big falls. Notable examples include Intel and Microsoft, added to the Dow in November 1999, and Bank of America, which was added in February 2008. On the flip side, stocks often perform well after being booted from the index, with Hewlett-Packard being the most obvious recent example. (The stock is up about 55% since being dropped from the Dow in September 2013.)
This is by no means a recommendation or a forecast but I can assure you some professional investors are right now looking into a paired trade: Short Apple-Long AT&T. (Update: In 32 of 50 Dow changes from 1928 to 2005, the deleted Dow stock outperformed the added name, and the portfolio of stocks removed gained 19% over next 250 trading days vs. a 3% gain for stocks added, according to this 2005 academic study by economists at Pomona College.)
Something else to think about amid the "Apple's going into the Dow" hoopla today.
Aaron Task is Editor-at-Large of Yahoo Finance. You can follow him on Twitter at @aarontask or email him at altask@yahoo.com.
