At the close of business last Friday, August 28, 2020, Apple (AAPL), the first company to ever reach a market cap of $2 trillion, split its stock 4-for-1 effective for the following Monday’s trading session. This is its fifth split since going public in 1980. Apple’s stock price went from just shy of $500 per share at the close on Friday (8/28) to open at $127.58 on Monday (8/31). The total value of Apple didn’t fall, however, because while the price of a share was cut by 75%, there are now 4 times as many shares outstanding.
Before the split, Apple was the biggest component in both the Dow and the S&P 500. This fact has prompted some concern about concentration risk in major U.S. indices, but the problem was clearly more of an issue in the Dow than the S&P 500 – at least before the Apple share split. What about now, after the split?
While Apple’s weight in the S&P 500 rose marginally over the weekend due to a rise in its (split-adjusted) share price, it has slipped from the number one spot in the Dow to the 17th most important – not even in the top half!
Index Construction Matters
Why? Because the Dow uses an index weighting methodology that weighs its component stocks according to their share prices. Because of the share split, Apple’s share price fell, leading to a massive reduction in its weight in the Dow. And there were even more knock-on effects! This decrease in the weight of Apple caused a corresponding fall in the weight of the technology sector, enough that Dow Jones felt compelled to replace three of the index’s constituents at the same time to roughly balance the overall weight of the tech sector. Interestingly, each of these new additions has a greater weight in the new Dow than Apple.
But should a stock split really change a company’s weight in an index, or the weight of other companies that index holds? Does it make sense for Apple to go from having the most influence on the index’s value one day to being middle of the road the next — even when it’s still the most highly valued company in the world? In our view – no it doesn’t. But don’t just take our word for it – investors have largely voted with their dollars on this as well. According to the Wall Street Journal, there is about 30 billion in index funds tracking the Dow versus over 11 trillion tracking the S&P 5001.
Are price-weighted indices obsolete?
Holding just 30 stocks, the Dow was created almost 125 years ago in 1896. Before the modern computing era, it made sense to use a price weighting scheme to simplify the index calculations. But now that computing power is cheap and plentiful, it is much easier to use more intuitive, sensible weighting schemes like the market cap weighting methodology used by the S&P 500.
A stock split shouldn’t have any bearing on how important that stock’s weight is in an index. But in the recent case of the Dow, while the overall index level didn’t change, Apple’s recent stock split had a massive impact on the weights of its members. Long story short – Apple’s weight in the Dow went down dramatically over the weekend. We think investor’s focus on the Dow should follow it down as well.
Still concerned about concentration risk?
And if you are still concerned about concentration risk, a clear trend in both the Dow and the S&P 500 over the past few years, there is an alternative. Active management can provide something that passive index following may not – allocations to regions, sectors, styles, or companies based on potential investment opportunity, not price or market capitalization.
To download a copy of this commentary, click the button below.