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Apple in the Dow

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When the rumor surfaced a couple of weeks ago that Apple might be added to the venerable Dow Jones Industrial Average, a strange thing happened: Apple’s price rose on the news. One might think that Apple, the very epitome of a modern, 21st-century corporation, might have nothing to gain from the Dow, a relic of an age when investors followed their stocks via tickertape rather than online portfolios.

But still, the stock rose by 2.6 percent on the day the rumor was printed by several reputable publications, following a supposition by Sanford Bernstein that Apple might be getting ready to join the Dow. The Dow’s basket of 30 massive stocks may not be the watchword for the equity market that it was back in the gray-flannel-suit days, but it still is one of the watchwords of the investing community.

The last time the Dow made a change to its components was back in 2009, when Cisco Systems and Travelers Corp. were added, while General Motors and Citigroup were dropped. GM was at that point entering bankruptcy protection, while Citigroup was avoiding bankruptcy by taking a $45 billion taxpayer bailout. (Ironically, Citicorp and Travelers had merged in 1998 to create Citigroup, although Travelers was spun back into its own company in 2002.)

At that point, June 8, 2009, Cisco felt very little impact from joining the Dow. It closed at $19.87 on June 8th, and $20.08 on June 9th. Travelers showed a similar pattern: It closed at close to $44 on June 8th, then gained a grand total of 12 cents after being added to the Dow. It then spent the next month losing ground.

So if simply joining the Dow Jones average doesn’t provide a price bump, why did Apple’s stock respond to the rumors? One simple answer is: It didn’t respond to the rumors but was simply moving on some other piece of news, or on nothing at all. It’s important to remember that just because the media reports that a stock moved for some specific reason, that doesn’t necessarily make it the case.

But in the specific case of Apple, there are reasons to believe that a Dow announcement would indeed benefit the stock. For one thing, membership in the Dow would likely be accompanied by a stock split. Apple’s share price is currently riding at over $630. The Dow weights its components by simple share price, which means that if Apple joined the index right now, it would have as much influence on it as the entire bottom half of the Dow stocks combined. IBM, with the largest share price of all the current Dow stocks, carries about a third of Apple’s weight.

(In contrast, the S&P 500 weights its components by market value. So Apple has a disproportionate effect on that index as well, as the most valuable company in the world, but it’s still just about 4.5 percent of the index’s total value.)

So Apple would have to split its stock before it joined the Dow perhaps by something as drastic as six to one, bringing the share price down to around $100. There are only two Dow stocks right now trading over $100: IBM and Chevron. That would provide a bit more liquidity to the stock, and remove some psychological barriers for investors — it’s a lot easier to project higher valuations for a stock at $95 than it is for one at $595. The bounce Apple’s stock got from the Dow rumor probably reflected the potential split more than anything else.

Joining the Dow would also help to cement the Apple dividend, which started just two quarters ago. Although the Dow doesn’t specify that every stock in the index must pay a dividend, in actual fact, the 30 stocks now listed do pay one. Apple is the only dividend-paying company with a market cap of more than $215 billion that is not in the Dow.

So what needs to happen next? Kraft will possibly be dropping off the Dow when it spins off its U.S. grocery business, a move that the board approved earlier this week. The spinoff is scheduled to happen on October 1. Kraft is already in the bottom third of Dow stocks in terms of market value, so a reduction would probably make it too small to warrant continued inclusion. That’s what happened in 2008, when Altria was dropped after it spun off its overseas tobacco unit.

In the end, adding Apple to the Dow would certainly have more effect on the Dow than it would on Apple. If the DJIA is supposed to stand as the barometer of American stock prices, it loses credibility if it doesn’t include the single most important American stock.

For more from Tom Nawrocki, see:

America’s 10 Biggest IPOs

Dividend Nation

Investor Sentiment as a Contrarian Indicator