If the 'ridiculous' Dow had chosen Apple instead of Cisco

An exercise in Wall Street 'what ifs?'

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After the Dow Jones Industrial Average climbed over 13,000 last week, San Jose Mercury News columnist Mike Cassidy made an impassioned case for including Apple in the index, a position he buttressed in part by citing an analysis by Adam Nash of Greylock Partners.

No one, including Cassidy and Nash, believes that Apple's inclusion will happen any time soon, if ever. However, it could have happened - at least hypothetically -- back almost three years ago now when Cisco was chosen to replace General Motors in the Dow lineup of 30 companies.

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Greylock's Nash wrote last month on his personal blog:

The question I explored was simple - what would have happened if (Dow Jones) had replaced General Motors with Apple on June 8, 2009 (instead of with Cisco).  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.

What would have happened is that the Dow Jones Industrial Average - the most widely cited measure of stock market health and a major contributor to general public attitudes toward the economy - would have fared better by roughly the difference between Apple's phenomenal performance and Cisco's anemic one since that time.

Ah, but the idea of Apple (or Google, if you're wondering) being included in the Dow is fanciful at best, as the Dow Jones Indexes' Indexology blog attempts to explain in a Feb. 8 post: "Typically a company is added to The Dow only if (it) has an excellent reputation, demonstrates sustained growth and is of interest to a large number of investors. While it's true that both Apple and Google would certainly seem to meet these criteria, this qualification doesn't necessitate their inclusion in The Dow-nor does their sheer size, although it also weighs in their favor. The Dow's methodology allows for subjectivity, and ultimately stock changes are made at the discretion of the Averages Committee."

So what's the problem? In a word: price. Apple and Google trade at such high prices that their inclusion would skew the Dow both today and historically.

nash

Nash thinks little of Dow's explanation - especially as it applied to Apple vs. Cisco circa. 2009 - but he reserves his greater scorn for something other than that discretionary decision: the Dow Jones Industrial Average itself:

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.

Again, this wouldn't really matter all that much aside from the academic exercise if not for the fact that the Dow Jones Industrial Average matters ... it matters a whole lot. For many Americans, that number - and its little brother the Nasdaq - are the only two pieces of financial news they'll hear and potentially absorb on anything approaching a daily basis.

Nash did the math. Had Apple instead of Cisco replaced GM in 2009, we wouldn't be talking about  the Dow and 13,000 because it would be near or above 15,000 by now.

Remember two things:

A committee made that decision using "subjectivity" and "discretion."

And in a presidential election year, nothing matters more than public perceptions about the economy.

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