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I'm taking an investing and personal finance class in school. I was assigned to ask someone who knows about the stock market why big companies like Apple and Google aren't included the Dow Jones Industrial Average (DJIA) even though they're doing really well?


Ed. Note: After this question was originally asked, Apple joined the Dow Jones Industrial Average in March of 2015.

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Please let me know what I can do to improve this question. – DavinKF Sep 11 '12 at 0:35
    
Would you call Apple or Google Industrial companies? The DJIA is for Industrials as there are other DJ indices for Utilities and Transportation companies is something else to consider here. – JB King Apr 27 '13 at 19:37
    
If the metric for "Membership in the DJIA" was "doing really well", it wouldn't be a very good proxy-measure for the overall market, would it? – abelenky May 3 at 18:47
up vote 17 down vote accepted

That is a pretty exclusive club and for the most part they are not interested in highly volatile companies like Apple and Google. Sure, IBM is part of the DJIA, but that is about as stalwart as you can get these days.

The typical profile for a DJIA stock would be one that pays fairly predictable dividends, has been around since money was invented, and are not going anywhere unless the apocalypse really happens this year. In summary, DJIA is the boring reliable company index.

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You make it sound like boring and reliable is a bad thing in investing. I find the opposite to be true. – user4127 Sep 11 '12 at 13:13
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Didn't mean to imply that. Microsoft is probably the hippest of the bunch. – JohnFx Sep 12 '12 at 3:11

Traditionally, the Dow Jones Industrial Average (DJIA) was only comprised of stocks that were traded on the New York Stock exchange. Neither Apple (AAPL) nor Google (GOOG) are traded on the New York Stock Exchange but instead are traded on NASDAQ. All NASDAQ tickers are four characters long and all NYSE tickers are only three or less characters long (e.g. IBM or T (AT&T)).

However in 1999, MSFT became the first NASDAQ stock to be included in the DJIA. Given that AAPL now has the largest market capitalization of any company in U.S. history, I think it is likely if they retain that position, that they would eventually be let into the DOW club too, perhaps, ironically, even supplanting Microsoft.

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I think there are shorter tickers as well. NYSE:F for example. – littleadv Sep 11 '12 at 0:47
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Counterexamples: MSFT and INTC. news.bbc.co.uk/2/hi/business/486752.stm ... and the DJIA has since added CSCO, too. Current DJIA components: ca.finance.yahoo.com/q/cp?s=%5EDJI .. (removed my downvote after your edit :-) – Chris W. Rea Sep 11 '12 at 0:47
    
Thanks for the suggested improvement Chris! – WilliamKF Sep 11 '12 at 0:55

In addition to the answers provided above, the weight the Dow uses to determine the index is not the market capitalization of the company involved. That means that companies like Google and Apple with very high share prices and no particular inclination to split could adversely effect the Dow, turning it into essentially the "Apple and Google and then some other companies" Industrial Average.

The highest share price Dow company right now, IIRC, is IBM. Both Google and Apple would have three times the influence on the Index as IBM does now.

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The Dow Jones Industrial Average (DJIA) is a Price-weighted index. That means that the index is calculated by adding up the prices of the constituent stocks and dividing by a constant, the "Dow divisor". (The value of the Dow divisor is adjusted from time to time to maintain continuity when there are splits or changes in the roster.) This has the curious effect of giving a member of the index influence proportional to its share price. That is, if a stock costing $100 per share goes up by 1%, that will change the index by 10 times as much as if a stock costing $10 per share goes up by the same 1%.

Now look at the price of Google. It's currently trading at just a whisker under $700 per share. Most of the other stocks in the index trade somewhere between $30 and $150, so if Google were included in the index it would contribute between 5 and 20 times the weight of any other stock in the index. That means that relatively small blips in Google's price would completely dominate the index on any given day.

Until June of 2014, Apple was in the same boat, with its stock trading at about $700 per share. At that time, Apple split its stock 7:1, and after that its stock price was a little under $100 per share. So, post-split Apple might be a candidate to be included in the Dow the next time they change up the components of the index. Since the Dow is fixed at 30 stocks, and since they try to keep a balance between different sectors, this probably wouldn't happen until they drop another technology company from the lineup for some reason. (Correction: Apple is in the DJIA and has been for a little over a year now. Mea culpa.)

The Dow's price-weighting is unusual as stock indices go. Most indices are weighted by market capitalization. That means the influence of a single company is proportional to its total value. This causes large companies like Apple to have a lot of influence on those indices, but since market capitalization isn't as arbitrary as stock price, most people see that as ok. Also, notice that I said "company" and not "stock". When a company has multiple classes of share (as Google does), market-cap-weighted indices include all of the share classes, while the Dow has no provision for such situations, which is another, albeit less important, reason why Google isn't in the Dow. (Keep this in mind the next time someone offers you a bar bet on how many stocks are in the S&P 500. The answer is (currently) 505!)

Finally, you might be wondering why the Dow uses such an odd weighting in its calculations. The answer is that the Dow averages go back to 1896, when Charles Dow used to calculate the averages by hand. If your only tools are a pencil and paper, then a price-weighted index with only 30 stocks in it is a lot easier to calculate than a market-cap-weighted index with hundreds of constituents.

References

About the Dow Jones Averages.

Dow constituents and prices

Apple's stock price chart. The split in 2014 is marked. (Note that prices before the split are retroactively adjusted to show a continuous curve.)

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