After many years of speculation and a healthy 7 for 1 stock split to boot, the folks at Dow Jones finally added Apple into the venerable Dow Jones Industrial Average effective the close on March 18. This had to be one of the worst kept secrets on Wall Street for years. As I mentioned in my 2015 Fearless Forecast, I thought this would happen in 2015. There were no excuses left not to add the tech giant and bellwether. In two days, Apple will be in and AT&T will be tossed to the curb.
Does this really matter for the Dow?
Yes it does in a big way. Unlike the S&P 500 which is weighted by market capitalization or value of the company, the Dow is uniquely weighted by price with a divisor. In the simplest of terms that means that a $30 stock stock going up $1 has the exact same impact as a $200 stock going up by $1, which doesn’t make a whole lot of intuitive sense. Apple and Visa typically rise or fall several dollars each day, but lower priced stocks like AT&T almost never see that kind of price movement.
In short and without getting too technical, as of the last Dow Jones Industrial Average change in 2013, a $1 move in a component stock equals 6.42 Dow points. Now, imagine what the impact will be when Apple joins and AT&T leaves. You can expect more volatility in both directions. In a bull market, the more expensive stocks can juice the index to much higher highs. In reverse, the index can suffer mightily during a bear market.
Before the Apple bulls start popping champagne corks to celebrate, entree into the Dow may not be all candy and dancing elephants. History shows some perverse results with companies leaving the index far outperforming those joining the index. And who could forget Dow Jones adding Microsoft and Intel in late 1999, just as the Dotcom bubble was about to burst.
Since 1991, stocks added to the Dow had a median 12 month return of 12%, but an average return of 6%. Stocks removed from the Dow saw returns more than 25% better than those added and even better of late although my research had a few holes for the stocks leaving the index.
In short, Apple bulls would be best served to expect increased volatility and a period of intermediate-term underperformance from being added to the prestigious Dow Jones Industrial Average.
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