The shakeup in the Dow Jones Industrial Average announced Tuesday had some investors thinking tech giants Apple (AAPL) and Google (GOOG) were snubbed from the venerable index. However, the benchmark’s quirky weighting scheme makes it unlikely that stocks with high share prices will join the index.
The $11.4 billion SPDR Dow Jones Industrial Average ETF (DIA) will see three of its 30 holdings replaced with new stocks, according to an announcement Tuesday.
The changes will go live when the market opens on Monday, Sept. 23.
“The index changes were prompted by the low stock price of the three companies slated for removal and the Index Committee’s desire to diversify the sector and industry group representation of the Index,” S&P Dow Jones Indices said in a press release announcing the shuffle.
Hewlett-Packard and Alcoa have been the worst performers in the index over the past three years.
The Dow Jones Industrial Average has been calculated since 1896 and the stocks are picked by the editors of The Wall Street Journal.
“Unlike most indexes, the DJIA weights its constituents by their share price, rather than market cap. So, even though Exxon Mobil has a larger market cap than IBM, it receives a lower weighting in the portfolio because IBM has a higher share price,” says Morningstar analyst Alex Bryan in a report on DIA, the Dow ETF. “Price weighting is a relic from [the] 19th century that was adopted primarily because limited computing power made alternatives impractical. This simple price averaging approach that gives higher-priced stocks larger portfolio weights does not have a sound economic basis.”
Price weighting also limits the index committee’s selection options, he added.
“Although Apple and Google are leaders in their fields, if either company were included in the index it would account for more than 20% of the portfolio, which would distort the Dow’s representation of the U.S. market,” Bryan wrote. “The index construction methodology does not follow mechanical rules, so there are no firm guidelines dictating how or when the committee overseeing the index will pick new constituents.”
Google shares closed near $888 a share on Monday, while Apple is trading around $500 a share. Apple is the world’s most valuable public company with a market cap of about $460 billion.
Full disclosure: Tom Lydon’s clients own AAPL and GOOG.
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