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.