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How an Apple Stock Split Would Impact ETFs

tlydon@globaltrend.com (Tom Lydon)

Today Apple (AAPL), which we have mentioned recently as having a lofty 18% weighting in the Nasdaq-100 PowerShares QQQ (QQQ) and a 4.54% weighting in the S&P 500 and is the largest single component weighting in both indexes, has rallied more than 2.5% to as high as $611 on “rumors of a stock split and/or dividend.”

We are not focusing too much on the rumor of a “dividend” but more-so the possibility of a stock split.

The reason being, many market observers have commented on the inclusion of Apple into the Dow Jones Industrial Average but the fact that the index uses a “price weighted” methodology, there have always been issues here.

Apple, with a $600 handle, would have undue pressure on the DJIA index itself on a daily and intraday basis as the “second largest” weighting in the index would be (the top weighted name in the index currently, IBM, which itself has a $197 handle today). In fact, Barron’s and other top media venues have commented on “what if” scenarios where Apple stock may someday join the Dow Jones on the basis that it is truly, as a company, representative of the “new” U.S. economy. The problem is, the feasibility of adding AAPL at this  juncture given it’s $600 handle.

Let’s rewind the clock to just last Tuesday/Wednesday, as AAPL was the most anticipated piece of news at that time last week with their expected earnings release. The stock, which was trading above $600 last Tuesday, plunged as low as $570 on Wednesday, which is approximately a 5% drop, peak to trough. This “intraday” move would have had severe overnight/intraday repercussions on the Dow Jones Index, as AAPL would have had 3 times the “price” weight on the index than the next largest equity component, IBM, and undoubtedly, the index would have “appeared” to have been down much more, just on the basis of AAPL’s stock performance that day, than it actually “was” on the whole.

This possibility, has always concerned the folks at Dow Jones as well as market pundits as there are a handful of market participants and observers whom still monitor the DJIA as a worthwhile barometer of market “health.”

In the past decade or so, many have commented on the “increasing irrelevance” of the DJIA on the basis of some of the points above, and thus have tracked the S&P 500 and even “other” newly developed or “equal weighted” indexes such as the “equal weighted S&P 500 Index” via RSP, as being more fairly representative of what the index performances are actually telling us and in not giving us a distorted view of market internals (for example in the case of the “post AAPL earnings Wednesday” scenario from last week which could very well have happened if AAPL was “in the Dow” at the time.)

So what do these rumors and the sudden movement of AAPL stock today (given the relative calm in the markets in general (and lighter volume) both yesterday and today) mean for the market and AAPL specifically. We will have to watch closely to see if the rumor specifically of a potential stock split does indeed have any truth to it, because an announced stock split would obviously help the folks at Dow Jones make a quicker decision in potentially adding AAPL to their index, on the basis that it would “work better” if AAPL had a lower notional price.

Thus, the price weighted index itself, the DJIA, would not necessarily be unduly influenced by the day to day action in AAPL if the stock were say “$60 (implying a 10 for one split). If this were indeed to happen from start to finish (i.e. rumor becomes truth, AAPL announces stock split, AAPL eventually becomes a Dow component at a fair “price”, i.e. $200 or less) there will indeed be money in motion for any indexes/derivatives and managers that are benchmarked if not directly invested in and/or linked to the DJIA. Thus, any upward price pressure in AAPL stock itself, would be felt also in the NDX (given the 18% and rising, current weighting), and for the same reasons, in the SPX (given the 4.54% and rising, current weighting).

PowerShares QQQ

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Full disclosure: Tom Lydon’s clients own QQQ and AAPL.