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06 Mar 2015
Bloomberg (and everyone else) are reporting that Apple has finally been added to the Dow Jones Industrial Average. No surprise about that, it was inevitable once their stock split last year, but I was somewhat surprised to see that they kicked out at&t to make room for it.
The Dow was set up in the 1890s, when the only way to do arithmetic was by hand. So Mr. Dow calculated his index by adding up the share prices of some big companies (initially 10, later 30), and that was the index. Later, as the companies were changed, since the share prices of the outgoing and incoming companies weren't the same, they added a multiplication at the end of a factor that kept the index from jumping up or down on the date of the change.
As has often been noted, while the simple calculations were important in the 1890s, it's a ridiculous way to create an index, since share prices are entirely arbitrary. A company with a $100 stock can do a 2:1 split and drop its price to $50, or less often a 1:2 reverse split and raise its price to $200, with no effect at all on what the stockholders own. Other indexes like the S&P 500 use a more reasonable approach weighted by the total market value of the company, so stock splits don't matter, but even the S&P does manual twiddles in events like stock buybacks.
Apple's share price had rocketed up to close to $700 last year. That meant if they removed at&t, whose stock was and is about $35, and replaced it with $700 Apple, now Apple would be 20 times as much of the index as at&t was. The next highest priced stock is Visa at about $200, who have a split scheduled down to $50, and Goldman Sachs at about $180. So Apple's $700 price would make it over three times as large a part of the Dow as anything else. That was too scary. But last year Apple did a 7:1 split, so now it's closer to $125, in the same ball park as other Dow stocks, so welcome aboard.
What this mostly tells us is that the Dow is a terrible index of how the stock market is doing. Except that everyone follows it, and there are index funds and ETFs that let you buy and sell its stocks as a group, so it's a self fulfilling misleading prophecy.
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