There’s no good excuse for keeping America’s biggest company out of the iconic industrial average. By Manuel Schiffres, Executive Editor May 9, 2014 There’s something rotten about the Dow Jones industrial average, and Apple (symbol AAPL) is at the core of the problem. How else to describe it when the world’s most famous and most closely watched measure of the U.S. stock market excludes America’s biggest and most-profitable company?See Also: Why It’s a Mistake to Write Off Apple Adding Apple to the Dow isn’t an action that will necessarily push up the stock’s price, as typically happens when a company is added to S&P 500. After all, index funds that track the various Dow averages contained only about $30 billion at the end of 2013 (the latest date for which figures are available), while nearly $1.6 trillion was indexed to the S&P 500 at the end of 2012. No, adding Apple, which booked $38 billion in profits over the past year, is about making the Dow a better barometer of American industry. Sponsored Content The Apple anomaly could be easily rectified, however. The company’s chances of joining the Dow will increase enormously come June 9, when the maker of phones and computers splits its shares 7 for 1. On that day, Apple investors will hold seven times as many shares, but those shares will trade at one-seventh of the previous close’s price. That means Apple shares, which now fetch about $600 apiece, will trade for about $85 each after the split. Advertisement What does the split have to do with Apple’s possible inclusion in the Dow? To understand that, you have to know how the Dow works. Most market benchmarks, such as Standard & Poor’s 500-stock index, are cap-weighted. That means the bigger a stock’s market capitalization—share price multiplied by the number of shares outstanding—the more influential it is in the index. A stock with a market cap of $100 billion carries 100 times more weight than a stock with a market cap of $1 billion. The Dow is different. It is a price-weighted index. The higher a stock’s price, the more its impact on the Dow’s movements. In Dow-land, a stock that trades at $200 is ten times more important than a stock that trades at $20. A price-weighted approach results in quirks. For example, Visa (V), trading at $209, is the highest-priced stock in the Dow industrials. Moves in Visa’s share price carry about five times the impact of moves in Microsoft (MSFT), which trades for a bit less than $40. But in terms of market cap, Microsoft ($338 billion) is nearly three times as large as Visa ($127 billion). Visa carries nearly ten times the weight of Cisco Systems (CSCO), which, at $23, is the lowest-priced stock in the Dow. Yet in terms of market value, Cisco ($119 billion) and Visa are within shouting distance of each other. Apple’s market cap is $505 billion, nearly $70 billion greater than the U.S.’s next biggest company, ExxonMobil (XOM)—which, of course, is already in the Dow. (All shares prices and markets caps are as of May 8.) David Blitzer, chairman of the committee that oversees both Dow Jones and Standard & Poor’s indexes, tells me that price is indeed a factor when the group weighs changes in the industrial average (as well as the Dow transportation and utility averages). “When the average price of a Dow stock is $65, you can’t put in a Berkshire (BRK.A) or a Google (GOOGL) at its pre-split price because it would dominate everything,” he says. On the other side of the coin, “if we put something into the Dow selling for $7, we might as well just have 29 stocks” in the index. But adding a stock with a share price between $50 and $100 “would not mess things up,” Blitzer says. So that would put Apple, at a post-split price of about $85, in the sweet spot for Dow inclusion. Advertisement Not surprisingly, Blitzer is mum about Apple’s prospects for joining the Dow. But he does say he’s satisfied with the average’s current composition. The average contains no single-digit stocks, and none of its constituents is heading for oblivion, as Bethlehem Steel was when it was removed in 1997 and as Eastman Kodak was when it was ousted in 2004. And this raises another issue. For Apple to go into the Dow, something has to exit. Dropping Cisco would make some sense because of its low price and because replacing it with Apple would be sector-neutral. But with a market cap of $119 billion, Cisco isn’t exactly an inconsequential company. (Memo to CEO John Chambers: If you think staying in the Dow is important for Cisco’s image, why don’t you just engineer a 1-for-3 reverse split? You’ll boost Cisco’s share price to $69 without hurting the company or any of your shareholders, and you’ll make the S&P/Dow index committee happy.) Another candidate for removal is drug giant Pfizer (PFE), which trades at just $29 but boasts a hefty market cap of $205 billion. You could justify giving Pfizer the boot because, as part of its proposal to acquire England’s AstraZeneca (AZN), it would change its domicile to the United Kingdom (though its operating headquarters would remain in New York City). But in 2010, S&P revised its rules to allow for reinstatement in the S&P 500 of some companies that had been removed from the index because of a change in domicile. Because the same criteria apply to the Dow, moving across the pond (at least technically) wouldn’t earn Pfizer automatic ejection from the Dow. Plus, dropping Pfizer would leave the average with just two pure health-care-products companies—Johnson & Johnson (JNJ) and Merck (MRK). If Blitzer and his colleagues simply wanted to drop the smallest Dow stock, their fall guy would be the Travelers Companies (TRV). Its market cap of $31 billion is $30 billion less than the second-largest Dow stock, DuPont (DD). But the insurance giant trades at $91, which means it’s in the ideal share-price range for the index. Unless one of the 30 incumbents stumbles or changes its stripes in a way that would disqualify it from inclusion in the average, Apple may have to wait a while longer to join the Dow. But there is no question that Apple is ripe for inclusion in the hallowed index once it splits its stock.