Part 1: What Does the Apple Stock Split Really Mean
Some of you have asked us this question over the last month so we finally decided to answer it. The real answer is a bit complicated but also quite interesting – in a geeky financial advisor sort of way. I learned a few things while I was researching this topic so hope you will too!
Now, before I get to that actual answer, we need to start with some information on the Dow Jones Industrial Average – yes, you are reading this right - which we will do in this post. And then we will actually attempt to answer the question in the next post.
Spoiler alert, you may need a calculator.
A bit of history and math: the Dow Jones Industrial Average, aka DJIA
The DJIA is comprised of 30 large publicly owned companies which trade on the NYSE and the NASDAQ. It is designed to serve as a proxy for the broader economy. When people refer to the “stock market,” they are most often referring to the DJIA. As the economy changes and industries or companies become more or less relevant OR the price gets too high or too low (more on that later), the Dow composition changes. In fact the composition has changed 60 times since 1928! In late August, Salesforce, Amgen and Honeywell were added to replace ExxonMobil, Pfizer and Raytheon. (GE was replaced in 2018.) And of course Apple shares split at the same time.
Trivia alert:
1884 Original 12 DJIA stocks: American Cotton Oil, American Sugar, American Tobacco, Chicago Gas, Distilling & Cattle Feeding, General Electric, Laclede Gas, National Lead, North American, Tennessee Coal & Iron, U.S. Leather pfd, U.S. Rubber
August 2020 DIJA stocks: 3M, American Express, Amgen, Apple, Boeing, Caterpillar, Chevron, Cisco, Coca Cola, Dow, Goldman Sachs, Home Depot, Honeywell, IBM, Intel, Johnson & Johnson, JP Morgan Chase, McDonalds, Merck, Microsoft, NIKE, Procter & Gamble, Salesforce, The Travelers Company, United Health, Verizon, Visa, Walmart, Walgreens Boots Alliance, Walt Disney
OK here is where the math comes in. Unlike the S&P 500 and other indexes which are market cap weighted, The DJIA is price weighted. That means that in the S&P 500, the largest companies have the most weight. In the DJIA, the companies with the most expensive share price have the most weight. This is why the Dow is very careful to avoid adding stocks which have very high prices - they will have a disproportionate impact on the average. Apple was added in 2014 after its 7 for 1 stock split. This also explains why Amazon probably will not be added anytime soon! Although this price weighting has its share of critics, and seems a bit silly to us now, in the late 1800’s when the DJIA was formed, share price was the only easy/possible thing to measure in real time. In truth, the Dow has actually performed eerily similarly to the Wilshire 5000 which is the largest U.S. stock index.
So how is the DJIA calculated?
The “Dow 30” is calculated every day by adding the price of one share of each of the component stocks, divided by the “Dow Divisor.” The Dow Divisor is just a mathematical constant designed to determine the effect of a $1 move in any of the 30 stocks. Obviously we wouldn’t need this complication if stocks never split, companies never merged or declared dividends, or there were no changes to the 30 stocks in the Dow 30. But that would just be too simple!
Dow Jones Industrial Average = sum of price of 1 share of each stock on Dow 30 divided by the ”Dow Divisor”
and of course
“Dow Divisor” = sum of price of 1 share of each stock on Dow 30 divided by the Dow Jones Industrial Average
We won’t attempt to understand or explain the Dow Divisor calculation, but just know that the Wall Street Journal has the job of ensuring that the Dow Divisor is appropriately adjusted to ensure that historical accuracy of the DJIA is maintained, regardless of market changes.
The current Dow Divisor is 0.146. Let’s just accept this, even though it feels like a circular argument!
The important part is that with this Dow Divisor value, every dollar change in price of any Dow 30 stock results in a DJIA change of 1/0.146 or 6.8 points.
Clearly, the most expensive stocks have the most influence on the average. And prior to its split, Apple was by far the most expensive and also fastest growing stock in the Dow.
Next up: So what did the Apple split do to the Dow and what does that mean for average investors like us?