I was driving home on Sunday, listening to the radio, and it occurred to me how different the financial news would be if Apple ($AAPL) was in the Dow Jones Industrial Average (^DJI).

Of course, being who I am, I went home and built a spreadsheet to recalculate what would have happened if Dow Jones had decided to add Apple to the index instead of Cisco back in 2009.  Imagine my surprise to see that the Dow be over 2000 points higher.

In real life, the Dow closed at 12,874.04 on Feb 13, 2012.  However, if they had added Apple instead of Cisco, the Dow Jones would be at 14,926.95.  That’s over 800 points higher than the all-time high of 14,164 previously set on 4/7/2008.

Can you imagine what the daily financial news of this country would be if every day the Dow Jones was hitting an all-time high?  How would it change the tone of our politics? Would we all be counting the moments to Dow 15,000?

Why Cisco vs. Apple?

This isn’t a foolhardy exercise.  The Dow Jones Industrial Average is changed very rarely, in order to promote stability and comparability in the index.  However, on June 8, 2009, they made two changes to the index:

• They replaced Citigroup with Travelers
• They replaced General Motors with Cisco

The question I explored was simple – what would have happened if they had replaced General Motors with Apple on June 8, 2009.  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.

The Basics of the Dow Jones Industrial Average

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.

So what? Does it really matter?

It’s a fair critique.  Look, with 20/20 hindsight, there are limitless number of changes we could make to the index to change its value.  Imagine adding Microsoft and Intel to the index in 1991 instead of 1999?

I don’t think this exercise is that trivial in this case.  The Dow already decided to make a change in 2009.  They decided to replace a manufacturing company (GM) with a large hardware technology company (CSCO).  They could have easily picked Apple instead.

The end result?  People talk about the stock market still being “significantly off its highs” of 2008.  In truth, no one should be reporting the value of the Dow Jones Industrial Average.  But they do, and therefore it matters.  As a result, the choices of the Dow Jones committee matter, and unfortunately, there seems to be no accountability for those choices.

Appendix: The Numbers

I’ve provided below the actual tables used for my calculations.  Please note that all security prices are calculated as of market close on Monday, Feb 13, 2012.  The new Dow Divisor for the alternate reality with AAPL in the index was calculated by recalculating the appropriate Dow Divisor for the 6/8/2009 switch of AAPL for CSCO, and a recalculated adjustment for the VZ spinoff on 7/2/2010.

Real DJIA			DJIA w/ AAPL on 6/8/09
Company	2/13/2012		Company	2/13/2012
MMM	88.03		MMM	88.03
AA	10.33		AA	10.33
AXP	52.07		AXP	52.07
T	30.04		T	30.04
BAC	8.25		BAC	8.25
BA	74.85		BA	74.85
CAT	113.70		CAT	113.70
CVX	106.38		CVX	106.38
CSCO	20.03		AAPL	502.60
KO	68.44		KO	68.44
DD	50.60		DD	50.60
XOM	84.42		XOM	84.42
GE	19.07		GE	19.07
HPQ	28.75		HPQ	28.75
HD	45.93		HD	45.93
INTC	26.70		INTC	26.70
IBM	192.62		IBM	192.62
JNJ	64.68		JNJ	64.68
JPM	38.30		JPM	38.30
KFT	38.40		KFT	38.40
MCD	99.65		MCD	99.65
MRK	38.11		MRK	38.11
MSFT	30.58		MSFT	30.58
PFE	21.30		PFE	21.30
PG	64.23		PG	64.23
TRV	58.99		TRV	58.99
UTX	84.88		UTX	84.88
VZ	38.13		VZ	38.13
WMT	61.79		WMT	61.79
DIS	41.79		DIS	41.79
Total	1701.04		Total	2183.61
Divisor	0.13212949		Divisor	0.146286415
Index	12874.04		Index	14926.95

Calculating the “alternate divisor” requires getting the daily stock quotes for the days where the index changed, and recalculating to make sure that the new divisor with the new stocks gives the same price for the day. It’s a bit messy, and depends on public quote data, so please feel free to check my math if I made a mistake.