In part one, I explained how the S&P 500 index (^GSPC) and most index tracking ETF's are weighted. The weighting is based on a company's market capitalization, which means that since Apple Inc. (AAPL) is easily the largest company in the world, it carries the largest amount of weight within these investment vehicles. Furthermore in the past I explained how this amount of exposure to Apple may not be a good thing.
But, with Apple recently being added to the Dow Jones Industrial Average (^DJI) investors now have an index to park money and not feel over exposed to Apple due to its size. While the S&P 500 weights companies by its market cap, the Dow weights companies by its share price. Over the years, a number of analysts and market experts have said this is one of the Dow's major flaws and to an extent I would have to agree. But, because Apple is so much larger than all of the other companies within the market, I am very much in favor of this share price weighting format.
So here is what the Dow Jones does; the Dow takes all 30 components and gives each of them a percentage weight for the index. That percentage is based on how much each share of each company is trading for. For example Goldman Sachs Group, Inc. (GS) was currently trading at $187 per share making it the heaviest component in the Dow while General Electric Company (GE) was trading at $24 per share, making it the lightest component. Goldman's weight in the Dow was at 7.06% while General Electric only commanded 0.94% of the index.
As I have mentioned before, Apple commands about 4% of the S&P 500 and in the Dow that figure slightly more at 4.65%. But in the Dow, Apple is actually the fifth heaviest weighted stock, with the next four stocks all being at least 1% heavier than Apple.
If you were to by a Dow Jones index ETF such as the iShares Dow Jones US (IYY) or the SPDR Dow Jones Industrial Average ETF (DIA), if Apple has a bad year, it will not suppress the whole index. Within the S&P 500, Apple controls the same amount of weight at 112 other companies or 20% of the index while in the Dow, it controls the same weight as just 4 other stocks or 7.5% of the index.
The Dow's price-weighted system, while far from perfect, puts Apple on an even playing field with the other stocks in the index. If Apple has an amazing year, investors will do well regardless of whether they own an S&P 500 index ETF or a Dow Jones Index ETF. But, if Apple stalls or drops in the future, investors will likely be less affected by it if they own a Dow ETF.
Think about it this way; you own an S&P 500 ETF and Apple falls you need up to another 112 stocks to perform well just to make up the different from Apple. If you own a Dow ETF and Apple falls, the most number of stocks you would need to perform well to make up the difference is 4.
Furthermore, because the Dow is price-weighted and not market cap weighted, if Apple lags behind other stocks, its weighting in the Dow will likely fall even lower than the 4.6% it is now, making it even less of a concern in the future. Now the same could be said about the S&P 500 ETF, but Apple's market cap is more than double the next largest company, meaning it will take a very long time for Apple's dominance in the S&P 500 to be diminished.
And that may be the most important thing. Right now, Apple is a runaway train and by no means am I trying to make the prediction that Apple is going to have a bad 2015 or 2016. But, odds are that eventually Apple is going to have a tough year. And when it does, investors need to pay close attention to the different funds and ETFs which they own and how much weighting Apple carries within those investments.
INO.com Contributor - ETFs
Disclosure: This contributor held positions in Apple at the time this blog post was published. This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from INO.com) for their opinion.