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Apple, Cisco, and Dow 15000

I was driving home on Sunday, listening to the radio, and it occurred to me how different the financial news would be if Apple ($AAPL) was in the Dow Jones Industrial Average (^DJI).

Of course, being who I am, I went home and built a spreadsheet to recalculate what would have happened if Dow Jones had decided to add Apple to the index instead of Cisco back in 2009.  Imagine my surprise to see that the Dow be over 2000 points higher.

In real life, the Dow closed at 12,874.04 on Feb 13, 2012.  However, if they had added Apple instead of Cisco, the Dow Jones would be at 14,926.95.  That’s over 800 points higher than the all-time high of 14,164 previously set on 4/7/2008.

Can you imagine what the daily financial news of this country would be if every day the Dow Jones was hitting an all-time high?  How would it change the tone of our politics? Would we all be counting the moments to Dow 15,000?

Why Cisco vs. Apple?

This isn’t a foolhardy exercise.  The Dow Jones Industrial Average is changed very rarely, in order to promote stability and comparability in the index.  However, on June 8, 2009, they made two changes to the index:

  • They replaced Citigroup with Travelers
  • They replaced General Motors with Cisco

The question I explored was simple – what would have happened if they had replaced General Motors with Apple on June 8, 2009.  After all, Apple was up over 80% off its lows post-crash.  The company had a large, but not overwhelming market capitalization.  The index is already filled with “big iron” tech stocks, like Intel, HP & IBM.  Why add Cisco?  Why not add a consumer tech name instead?

In fact, there is no readily obvious justification for adding Cisco to the index in 2009 instead of Apple.

The Basics of the Dow Jones Industrial Average

Look, I’m just going to say it. The Dow Jones Industrial Average is ridiculous.

You may not realize this, but the Dow Jones Industrial Average, the “Dow” that everyone quotes as representative of the US stock market, and sometimes even a barometer of the US economy, is a mathematical farce.

Just thirty stocks, hand picked by committee by Dow Jones, with no rigorous requirements.  Worse, it’s a “price-weighted” index, which is mathematically nonsensical.  When calculating the Dow Jones Industrial Average, they take the actual stock prices of each stock, add them together, and divide them by a “Dow Divisor“.  They don’t take into account how many shares outstanding; they don’t assess the market capitalization of each company.  When a stock splits, they actually change the divisor for the whole index.  It’s completely unclear what this index is designed to measure, other than financial illiteracy.

In fact, there is only one justification for the Dow Jones Industrial Average being calculated this way.  Dow Jones explains it in this post on why Apple & Google are not included in the index.  To save you some time, I’ll summarize: they have always done it this way, and if they change it, then they won’t be able to compare today’s nonsensical index to the nonsensical index from the last 100+ years.

So what? Does it really matter?

It’s a fair critique.  Look, with 20/20 hindsight, there are limitless number of changes we could make to the index to change its value.  Imagine adding Microsoft and Intel to the index in 1991 instead of 1999?

I don’t think this exercise is that trivial in this case.  The Dow already decided to make a change in 2009.  They decided to replace a manufacturing company (GM) with a large hardware technology company (CSCO).  They could have easily picked Apple instead.

The end result?  People talk about the stock market still being “significantly off its highs” of 2008.  In truth, no one should be reporting the value of the Dow Jones Industrial Average.  But they do, and therefore it matters.  As a result, the choices of the Dow Jones committee matter, and unfortunately, there seems to be no accountability for those choices.

Appendix: The Numbers

I’ve provided below the actual tables used for my calculations.  Please note that all security prices are calculated as of market close on Monday, Feb 13, 2012.  The new Dow Divisor for the alternate reality with AAPL in the index was calculated by recalculating the appropriate Dow Divisor for the 6/8/2009 switch of AAPL for CSCO, and a recalculated adjustment for the VZ spinoff on 7/2/2010.

Real DJIA DJIA w/ AAPL on 6/8/09
Company 2/13/2012 Company 2/13/2012
MMM 88.03 MMM 88.03
AA 10.33 AA 10.33
AXP 52.07 AXP 52.07
T 30.04 T 30.04
BAC 8.25 BAC 8.25
BA 74.85 BA 74.85
CAT 113.70 CAT 113.70
CVX 106.38 CVX 106.38
CSCO 20.03 AAPL 502.60
KO 68.44 KO 68.44
DD 50.60 DD 50.60
XOM 84.42 XOM 84.42
GE 19.07 GE 19.07
HPQ 28.75 HPQ 28.75
HD 45.93 HD 45.93
INTC 26.70 INTC 26.70
IBM 192.62 IBM 192.62
JNJ 64.68 JNJ 64.68
JPM 38.30 JPM 38.30
KFT 38.40 KFT 38.40
MCD 99.65 MCD 99.65
MRK 38.11 MRK 38.11
MSFT 30.58 MSFT 30.58
PFE 21.30 PFE 21.30
PG 64.23 PG 64.23
TRV 58.99 TRV 58.99
UTX 84.88 UTX 84.88
VZ 38.13 VZ 38.13
WMT 61.79 WMT 61.79
DIS 41.79 DIS 41.79
Total 1701.04 Total 2183.61
Divisor 0.13212949 Divisor 0.146286415
Index 12874.04 Index 14926.95

Calculating the “alternate divisor” requires getting the daily stock quotes for the days where the index changed, and recalculating to make sure that the new divisor with the new stocks gives the same price for the day. It’s a bit messy, and depends on public quote data, so please feel free to check my math if I made a mistake.

49 Comments Post a comment
  1. Fantastic post — I honestly think more attention needs to be drawn to how little it really matters. The original creator actually only updated it about once per month to start and just used it as a rough guide for market movement of important companies.

    Also, you could probably write ten posts on the selection bias inherent in the index (companies doing poorly are taken out) and how it’s not at all accurate in understanding long term returns of the market.

    February 14, 2012
  2. I’d always known that the DJIA was an arbitrary mess that no one should take seriously, but this concrete example is terrific (and a little terrifying in its political implications). I’ll definitely be using it in the future. Thanks, Adam.

    February 14, 2012
    • Derek Kolb #

      This is not a concrete example of whatever it is you’re claiming. The Dow has a very specific purpose which is to perform as a barometer of the entire market, and the Dow does that reasonably well. The reason that the Dow works in this regard is that stable stocks are chosen for the index. AAPL is a growth monster, but it’s not an effective barometer for the market.

      February 15, 2012
      • The basic premise of my post was not that AAPL should be added to the Dow Jones Industrial Average per se, but that adding Cisco instead of Apple makes no sense. I don’t know how you define “stable”, but as of June 2009 Apple exceeds every definition of stable that Cisco did, unless you mean “stable = no growth”.

        February 15, 2012
  3. SI Hayakawa #

    Typo: “Look, with 20/20 hindsight, there are limitless number of changes we could make to the index to change it’s value.” Should be “its value” (possessive).

    February 15, 2012
  4. Fascinating analysis, Adam! It’s a great “what if” and highly engaging.

    P.S.: I’d missed your new gig. Congrats on that!

    February 15, 2012
  5. I have to give you credit for an interesting post. But if you’re discussing things like this, you must know that it actually doesn’t matter one bit. Apple is listed on Nasdaq and not Dow Jones. We can argue why it should or shouldn’t be but it doesn’t matter very much in the big picture. Dow is just an index as is Nasdaq. And whether it’s nonsensical or not (it may very well be); nobody grades an entire economy on just one index. One index is after all, just a slice of the economy with certain characteristics.

    Whether you like it or not, Apple and Google aren’t very mature or stable stockwise and so should probably not be on Dow at the moment. Being in one index or another doesn’t matter to Apple or the US economy in any way.

    February 15, 2012
    • The Nasdaq isn’t an index, it’s a stock exchange. The Dow Jones index is just that, a list of thirty stocks picked editorially by a third party. Until the late 1990s, all Dow Jones Industrial Average stocks were listed on the NYSE, but that changed with the addition of Microsoft and Intel in 1999.

      Apple is an older company than Cisco, a larger company than Cisco, a more profitable company than Cisco, and a faster growing company than Cisco. I’m curious what definition of “mature” or “stable” you are using to differentiate Apple vs. Cisco in June 2009.

      February 15, 2012
      • gef05 #

        Thank you for pointing this out: an exchange is not an index (and vice versa).

        February 16, 2012
  6. Craig #

    Great article. The AAPL example works terrifically. Cheers.

    February 15, 2012
  7. Excellent post, Adam!

    February 15, 2012
  8. Great article Adam. It is interesting to wonder how the political discourse in the US would be different if the Dow was hitting all-time highs.

    February 15, 2012
  9. I work in the markets, the Dow is just too narrow based for most people to look at for a measure of the market. This is why everyone looks at the S&P 500 so much.

    February 16, 2012
  10. Do you mind if I steal your idea for an article? I’m a professional journalist. Sorry, our policy is not to give credit to lowly blogs.

    February 16, 2012
  11. qazwart #

    Adam Davidson of Planet Money covered the Dow in the NYTimes magazine not long ago: http://n.pr/yMDChT. Adam explained that even Charles Dow, the “Dow” in Dow Jones, didn’t bother to look at his index more than a few occasions. The Dow is suppose to represent the movement of the market in very broad terms over long term time scales and not on a daily basis.

    Why wasn’t Apple chosen? Apple is just to volatile a stock to represent a long term average. Apple has had a tendency to boom and crash. In May 2008, it looked like the price of Apple stock would break 200. By August of that year, it was down to around 80 and didn’t break 100 again until the next May. By the Fall of that year, it was over 200. In 2011, Apple stock rose from 370 broke 400, then quickly lost all of its gain in less than one month.

    In fact, the S&P 500, the index that is a true index that represents the 500 largest companies, so it’s much broader than the Dow, and doesn’t depend upon the editorial judgments of a group of old rich white dudes has had its own “Apple” trouble. Apple is just too big and volatile which drags the whole index this way and that way: http://bloom.bg/zylnyU

    I’m happy for Apple that it broke 500 (and maybe even happier if I had bought Apple as I was thinking of doing when it was hovering 360 back in October). It wouldn’t surprise me if Apple dipped below 400 because the next iPad that will be announced in March won’t have the ability to weave straw into gold as many of the Apple rumor blogs will be reporting, then break 600 when everyone realizes that it has broken all previous sales records despite not having that must have straw-into-gold feature.

    February 16, 2012
    • To some extent, you are correct about how they try to remedy the inherent flaws in the Dow by selecting for stability.

      However, in this case, your argument is factually incorrect. According to Yahoo Finance, AAPL has a beta of 0.92, while CSCO has a beta of 1.21. Apple did drop in late 2008 by over 50%, but then again, so did many stocks.
      http://finance.yahoo.com/q/ks?s=aapl+Key+Statistics
      http://finance.yahoo.com/q/ks?s=CSCO+Key+Statistics

      So a selection process that optimized for stability wouldn’t have chosen CSCO over AAPL, which is the specific decision I’m questioning here.

      February 16, 2012
      • Ron #

        Dow chose Travelers over Aetna at last second to replace Citi. That would probably change the number as well if AET didn’t tank in 2009.

        February 17, 2012
  12. peg dash fab #

    How does the DJIA w/ and w/o AAPL look compared to the S&P 500?

    February 16, 2012
  13. This is hilarious. I knew the dow was largely useless, but price weighted?? The mind boggles.

    Actually, it makes perfect sense. Everyone in Wall Street knows that the Dow is completely useless, but many people do not. This information can be exploited to add extra profit to those who know and to take money from those who do not.

    The Nasdaq 100 is less stupid, but is probably even worse because normal people actually invest in funds based on it. Last year they cut AAPL’s percentage of the index by ~40% because AAPL did too well, and oddly enough, more than doubled MSFT’s shares in the index! https://indexes.nasdaqomx.com/docs/NDXSpecialRebalancePresentation.pdf
    And for some reason unknown to me, financial companies are not allowed in the Nasdaq 100.

    Anyway, it’s also interesting to see the opposite effects, how the S&P 500 and QQQ would have performed without AAPL.

    February 22, 2012
  14. Greetings Adam,

    A very interesting article and exercise.

    However, it seems that a more appropriate exercise would be to exclude AAPL from the Nasdaq 100 Index or the Nasdaq Composite Index instead of adding it to the Dow Jones Industrial Average. This way, you can see just how much worse off the Nasdaq 100 or Composite Index would be from the 2000 peak. If it currently isn’t part of the index then it is wishful thinking to add it to an index that isn’t a part of.

    As a sidebar, to arrive at a Dow level of 15,000 if you add APPL is actually a statically neglible amount above the February 10, 2012 level. A higher Dow Industrials isn’t the primary concern of most investors, instead, the general trend of the market is the main concern. if the primary trend is higher then investors tend to feel more confident about the flaw theory of buy-and-hold investing which creates a feedback loop. Whether it is 15,000 or 12,000, most investors only care about the general trend, the goal of an index, not the actual level.

    Additionally, your preference for a market capitalization weighted index overlooks the fact that stocks that are overvalued tend to have higher market caps. Therefore, you’re actually put in the position of buying or investing in the stocks that are at the higher end of their valuation range as opposed to the lower market cap stocks that tend to be relatively undervalued. This makes the investment in the S&P 500 an erroneous approach to value investing. This explains why the Guggenheim S&P 500 equal weighted fund (RSP) is up 140% from the March 3, 2009 low while SPDR S&P 500 fund (SPY) is up only 97% in the same time frame.

    It is understood that AAPL is arguably the most undervalued large cap company on the planet at the current time. However, by virtue of being an ultra large cap stock, it become difficult for investors to recognized that the new level of over/under-valuation has experienced a paradigm shift. In many companies like WMT, XOM, MSFT, CSCO etc. investors couldn’t discern when the shift from small cap hyper-growth ended and Mensch-like s-curve in a company’s numbers succumb to the forces of entropy and law of large numbers.

    As we’ve been able to demonstrate, even though IBM is at a near high in the price, based on Edson Gould’s (Barron’s contributor 1960’s and 1970’s) Altimeter, the stock can have valuation attributes that would justify buying the stock as Warren Buffett did recently. Though, it could also be argued that Buffett simply wanted to prop IBM’s price up which would also prop the Dow Industrial index.

    Regardless, this was an interesting and thought provoking piece. Thanks.

    April 25, 2012
    • Your comment is long enough to be a blog post in itself! :)

      Some quick answers to thought provoking statements:
      1) The Dow is an editorially determined index, so arguments about the quality of its editorial process is valid. Less so for largely quantitative indexes like the Nasdaq 100 or S&P 500.
      2) The Dow *is* important b/c literally everyone talks about it in volume. My blog post was a reflection of this sad fact, and how it is even affecting discussion of the 2012 election.
      3) The debate on fundamentals-based indexes and market capitalization-based indexes is relatively new and unresolved. Contrary to your assertion, the fact that equal weighted funds are up could be argued to represent an over-weighting of mid-caps and small-caps, which have outperformed in that time period. Comparing an equal-weight fund to a more thoughtful combination of large-cap, mid-cap, and small-cap index funds is more complicated.
      4) I believe that AAPL is systemically undervalued at this point b/c we effectively don’t understand how a company could be this successful, and therefore we can’t effectively price the risk of how long they can continue this success. It’s literally unprecedented at this scale to see sales growth, cash flow, profitability at this size and growth rate.

      Thanks for the note.
      Adam

      April 25, 2012
      • Greetings Adam,

        Thanks for your response. We love the topic and you write well making for a great discussion.

        The virture of the study of the Dow is that it has the longest uninterrrupted stock index in American history. The flaws are readily recognizable as you’ve adroitly pointed out. Even the Shiller extrapolation of the S&P 500 to the 1800’s is based on the Dow in the period before 1957, since the S&P 500 never existed before 1957. We have been able to prove, through the use of the Barron’s 50 index that the reason the Dow declined 89% in the 1929-1932 period was due to the high percentage of changes to the index in that period. The fact that Shiller uses the Cowles Commission data to extrapolate the S&P 500 beyond its actual existence, but that “hypothethtical” existence mirrors the price movement of the Dow, shows a lack of integrity in the data, which goes unnoticed.

        Additionally, the strongest argument for the S&P 500 index is that is a more diverse index and better at reducing risk of loss for investors (being diversified and more representative of the U.S. economy). However, we have demonstrated that since 1980, the S&P has underperformed the Dow (80/20) by falling more and rising less which defies the point of what a broadly diversified index should do. The theory dictates that a broadly diversified index should decline less and rise less. That hasn’t been the case 80% of the time since 1980, peak to trough.

        Naturally, the debate about equal-weighted index isn’t really much of a debate. A well thought out index based on the proclivities of investors who follow what is popular rather than what is undervalued, when it comes to investing, should be questioned. The point of referencing the equal weighting index was point out that the exceptional performance was with the use of all the same companies just a better representation of those that might be undervalued as opposed to the current market cap structure.

        Item 4 of your response is interesting because AIG, GE, XRX from the 1970’s, Northern Railroad from 1902 and a mulititude of others could be compared to what we’re seeing with AAPL today. However, we can appreciate your rational since it is in alignment with much that is being observed at the moment.

        Thanks again for the discussion. We’ve more to say on the topic but tried to be “brief.” Your work is very interesting and we’re glad that you voice is widely appreciated.

        April 25, 2012
  15. Great article, Adam. You clearly brought to light the need to look past the Dow to get a better “feel” for the market. I don’t pay attention to the Dow as a barometer of any kind. As pointed out in your article, it is far too narrow in scope to give any insight into the health of the market, much less the economy.

    Cheers!

    May 12, 2012
  16. Soyfama #

    It seems obvious that the Dow with thirty components would not give a broad representation of the overall market. However, nothing could be further from the truth. The Dow give a very good representation of the market from a diversification standpoint, and anyone that has plotted the Dow vs. the s&p would readily see that. Now price weighting of the constituents is a whole different ball game. The Dow equal weighted and rebalanced quarterly has far outperformed the price weighted Dow, and has crushed the s&p over time. On a separate note, contrary to what most believe Dow is quoted at its price return not its total return which includes dividends. The Dow total return is currently just under 25000 which in turn has shown far greater cumulative returns than most investors realize.

    June 14, 2012
  17. Rickyd #

    Forgive me for being late to the party , but where would the dow be had it kept gm and citi and made no changes ?

    January 16, 2013
  18. Would be great to see how much the Dow would have rose and fell if AAPL was included in the Index, based on the last year. Any updates?

    January 24, 2013
  19. Bill Ainsworth #

    If the Dow was priced in commodities (ie Gold), how close would it be to an all time high?

    March 5, 2013
    • Greetings Bill,

      This is exactly the same dilemma as with adding Apple to the index. When the stock or commodity is popular that is the time that the public seeks to change the composition of the Dow Industrials. This overlooks the history of the index since 1896. As we’ve seen with the idea about adding Apple, it would have worked out great when the stock price is climbing but a huge drag as the stock declined.

      Our article April 17, 2012 article titled “Considering the Downside Prospects for Apple” (found here: http://seekingalpha.com/article/503161-considering-the-downside-prospects-for-apple) explored the possibility of Apple declining all the way to $424 based on the work of Edson Gould.

      With regards to gold, when the view becomes pervasive that a gold component should be considered as part of the Dow, in determining how high the index would be, then the most reasonable view should be to consider the downside prospects for gold.

      However, if gold were added to the indexed, somehow or some way, then it would have been a horrible contributor to the performance of the index as it peaked at US$850 in 1980 and is “only” US$1,600 today (actually lower on inflation adjusted terms). At the same time, the Dow, was at 1,000 or less in 1980 and is now 14,500.

      The starting point makes all the difference. since the price of gold can be traced back to the beginning of the Dow’s roots, it [gold] would be a non-factor to the Dow’s appreciation.

      Regards.

      March 23, 2013
      • I think you misunderstood Bill’s question. He wasn’t asking about adding Gold to the Dow, he was asking about the Dow’s relative price if it were priced in Gold vs. Dollars. He’s implying that the Dow isn’t really at a high adjusted for the price of commodities (as a proxy for inflation, I’m assuming).

        As per rejecting changes to the Dow based on popularity, that’s not really a meaningful intellectual argument. Popularity, high or low, should be immaterial. The index should be constructed with some form of mathematical validity (price weighted literally makes no sense). Additions should be based on some form of criteria that are largely objective. Adding Cisco vs. Apple is still not a defensible decision, regardless of the ups and downs of AAPL.

        Adam

        March 24, 2013
      • Sorry about that Adam & Bill,

        If the Dow Jones Industrial Average were calculated to include dividends then it would be over the 1,339,410 level since inception (as of 2012, source: Zwieg, Jason. Dow 1,339,410: The Latest Milestone. Wall Street Journal. March 2, 2012. link- http://online.wsj.com/article/SB10001424052970204571404577257373285657442.html). This is double the level of the Dow since this same calculation was done in 1998 (source: Clarke and Statman. The DJIA Crossed 652,230. Winter 200. PDF link- http://shookrun.com/documents/djia-crossed.pdf).

        Because gold and the Dow are priced in dollars, there is little need to price the Dow in gold since an apples to apples comparision is already done in dollars.

        Best regards.

        March 24, 2013

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