Why Apple Isn't in the Dow

David Paul Morris/Bloomberg

By Roben Farzad

Since 1896, when the Wall Street Journal's first editor and co-founder, Charles Dow, compiled a portfolio of bellwether industrial stocks, the Dow Jones industrial average has sought to reflect the changing U.S. economy. The benchmark has sometimes been slow to keep up with the times. The Dow booted Woolworth for Wal-Mart (WMT) in 1997 and didn't add Microsoft (MSFT) and Intel (INTC) until 1999. Even so, the 30-member index remains the most widely recognized measure of the market. "With each rebalancing of the Dow Jones industrial average, the selection committee looks to ensure the Dow reflects the current sector composition of the U.S. market," says John Prestbo, editor and executive director of the Dow Jones Indexes, majority-owned by CME Group since February 2010.

Today the Dow is notable for one giant omission: Apple (AAPL), the world's leading tech stock. With a market value of $307 billion as of June 14, the maker of iPhones and Macs is the second largest company in the U.S., behind ExxonMobil (XOM), a Dow component, and almost as large as Microsoft and Intel combined. "Apple should be in the Dow," says Paul Hickey, of Bespoke Investment Group in Harrison, N.Y. "Just as there used to be a General Motors (GM) vehicle in nearly every American driveway, there's now an Apple product in practically every American household."

Apple's absence, says Hickey, has deprived the Dow of 1,000 points. He calculates that if Apple had been added to the Dow instead of Cisco (CSCO) in June 2009, when bankrupt GM was ousted, the blue chip index would have closed at 13,081 on June 14, 8.3 percent higher than its actual level of 12,076.

So why hasn't Apple joined the club that includes JPMorgan Chase, Kraft (KFT), Caterpillar (CAT), and other household names? The answer lies in the peculiar way the Dow index is calculated. Most benchmarks, including the Standard & Poor's 500-stock index, weight their components by market value, which is the share price times the number of shares outstanding. The Dow uses only one component of that equation: stock price. Thus IBM (IBM), at $164, holds the top weighting in the Dow, 10 percent, even though it is only third by market value. Meanwhile, because General Electric (GE), Alcoa (AA), and Bank of America trade in the teens, they represent a combined 3 percent of the Dow—less than a third of IBM's weight. Such distortions, says Jeffrey Yale Rubin, director of research for Birinyi Associates, are why "investors should realize that the Dow is just a subset of the entire market—not the entire market."

With a share price of about $330, Apple would dominate the Dow, accounting for more than 17 percent of the index. A 1 percent change in Apple's stock price would translate to a 23-point change in the Dow. That kind of outsize impact, says Rubin, "would pretty much make the Dow irrelevant. I agree: Apple should be in there. But at this price, you can't just put it in." The keepers of the Dow acknowledge the problem. "Apple, at its current price level, would distort the Dow," says Prestbo.

There are no hard or fast rules for making changes in the index. Prestbo and several colleagues seek out new candidates when a Dow component is merged out of existence, a price sinks too low—or whenever rebalancing seems necessary. "While we don't comment on future component changes," says Prestbo, "for the DJIA to accurately tell the market's story, all 30 stocks' prices must fall within a modest range."

Apple could get its share price into range by splitting the stock, something it last did in 2005. The company declined to say whether it had any plans to do so. "They seem to have no interest" in a split, says Brian Marshall, a Gleacher & Co. analyst who has a target price of $450 for Apple. Aside from the honor, the company has little to gain from joining the Dow. When companies are added to the S&P 500, their stocks can get a boost from index funds that have to add the shares to their portfolios. While there are trillions of dollars indexed to the S&P 500, only $37 billion are in funds that follow the Dow.

The Dow's Apple conundrum may only get worse. If its stock, up sevenfold since 2006, reaches $430, Apple will overtake ExxonMobil as the biggest company in the U.S., says Marshall. Perhaps Apple shareholders shouldn't be in a hurry to have the stock join the Dow. Noting that tech stocks Cisco, Intel, and Microsoft are down by a third, on average, since their inductions, Hickey says: "It's actually been the kiss of death."

The bottom line: As the No. 2 company in the U.S. by market value, Apple may deserve a spot in the Dow. But its $330 share price would distort the index.

Bloomberg Businessweek Senior Writer Farzad covers Wall Street and international finance.

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