For quite some time now Apple, Inc. (NASDAQ:AAPL) has been behaving as if it was a market index on its own. The phenomenal performance of AAPL accounts for a fairly large portion of the market's overall gains, so much so that portfolio managers not holding Apple are experiencing difficulties in meeting their investment goals, forcing analysts to start looking at the S&P 500 Index from a different angle.
Year-to-date, Apple has appreciated almost 50%, 49.14% to be exact, while the S&P 500 managed just 12.26% and Dow Jones only 7.28%. See the chart below:
Source: Google Finance
Apple started surging ahead after 2000, gaining 30% annually till January 2008. The sub-prime mortgage crisis saw AAPL falling by more than 50% - from $200 to $90. However, it rebounded with greater vengeance in the last five years, to $604 right now, showing an annual gain of an astounding 114.22%.
The current market cap of AAPL stands at $567.28 billion, which is way ahead of the $418.30 billion of Exxon Mobil (NYSE:XOM), which was the largest company in terms of market capitalization till Jan 25, 2012 (if you ignore PetroChina (NYSE:PTR), with a market capitalization of nearly two trillion dollars). AAPL is currently valued at $109.05 billion more than Microsoft (NASDAQ:MSFT) ($237.43 billion) and Google (NASDAQ:GOOG) ($220.8 billion) combined. In the case of NASDAQ, which comprises of a large number of tech companies, the market-value weight of Apple is even higher, more than Intel, Google and Amazon taken together.
However, valuation of AAPL is not the subject matter of today's discussion. It is more about its impact on the S&P 500 Index.
S&P 500 does not treat all its constituents equally. If that was the case, Apple would be just another stock and account for just as much as any other stock, which is 0.2% (1/500). The Index however is market-value weighted, meaning thereby that companies with higher market capitalization have a greater impact on the movement of the index than smaller-cap companies.
Apple's weight in S&P 500 was 1.3% in June 2008. If AAPL stock was to rise by 10%, it would cause the Index to rise by 0.13% (10%*1.3% = 0.13%). However, since June 2008, the share price of AAPL has risen by 255% (from $170.09 on June 27, 2008 to $604 at close of October 26, 2012). This means that it has caused the Index to rise by 3.31% (255%*1.3%). When it was at its 52-week high of $705.07, market-value weight of AAPL stood at 4.51%.
The extraordinary surge in the price of Apple has thus resulted in disproportionate skewing of the Index. The performance of the Index can no longer be said to be representative of the performance of the overall market. It is worth mentioning here that the S&P 500 Index was "designed to be a leading indicator of U.S. equities and is meant to reflect the risk/return characteristics of the large cap universe".
What analysts are now asking is whether the S&P 500 still reflects the risk/return characteristics of large US companies.
Investors who think that they have not done well if they did not beat the S&P 500 Index may want to do some rethinking as they can no longer assume that it reflects the average performance of all the components of the Index.
Here is an example of what I am trying to convey. Given below is a comparative chart of five of the top components of S&P 500: Apple, Exxon Mobil, General Electric (NYSE:GE), Chevron (NYSE:CVX) and Microsoft .
Lest it appears too confusing, the AAPL line is at the top in blue
Source: Google Finance
YTD increase in price in %
Market cap of AAPL is 34.09% of the total market cap of these five biggies of S&P 500 and the average YTD appreciation is 17.42%. What comes next is evident. If AAPL is taken out from this example, the average YTD of the other four drops down to almost half, 9.49% to be exact. This is the figure that is more reflective of the performance of the broader market.
The situation is much the same when we take the example of five of the more popular companies in the tech sector of S&P 500: AAPL, MSFT, GOOG, IBM and INTC
Source: Google Finance
YTD increase in price in %
Here again, the market cap of AAPL is 41.82% of the total market cap. The average YTD of all five is 11.59%. Without AAPL, the average YTD of the other four is a dismal 2.21% (however, that is again negatively skewed by the dismal performance of INTC).
Figures like these are forcing analysts firms such as Goldman Sachs, Wells Fargo and Barclays to look at the S&P 500 Index without Apple in order to get a clearer picture of overall market trends. Investors need to follow suit if they want to derive the right conclusions from the performance of their portfolios.
Let's look at it like this. They used to say that the S&P500 was the pulse of the market. Looking at this index, you could say how well the market performed.
Well, you cannot now, because of Apple. Apple is pulling the average up; if you take out Apple, the rest of the market is not performing as well as the index says it does.
So, who should worry about that?
Not you, if you have beaten the index without having Apple in your portfolio - you have done unbelievably well. If you did have Apple, though, you need to really take out Apple and see how the rest have done. Otherwise, what you are getting is a skewed result - the rest of your portfolio, just like the Apple-less market, might not have performed too well. Ergo, put more money into Apple.
If you maintain a portfolio that you manage yourself, and you consider a good annual performance if you beat the S&P 500, make sure you take all of the above into consideration. Basically, I would take Apple out of my portfolio, and see if everything else together has beat that index. If they have, I would have really done well.
However, policy-makers who thought they were happy because the market was doing so well according to the index, should be worried. Apple is skewing the picture of the market. It is making things look brighter than they actually are.
Here is something more that should get you thinking.
Apple is the most valuable company in the US but it is not included in the Dow Jones Industrial Average whereas tech companies such as Hewlett-Packard Company (HPQ) that are underperforming the broader market (HPQ's YTD performance is -45.3%), are still being retained. Ever wonder why?
The Dow uses a price-weighted average system unlike the S&P 500. The case against Apple's inclusion in the Dow is that it will overwhelm the Dow. The Dow holds other tech companies that have not been performing well over the last few quarters but they continue to be in the Dow.
However, for the sake of argument, it must also be conceded that Apple's success has been one part of the cause of the recent problems for HPQ. Additionally, to be eligible for inclusion in the Dow, Apple must pay a dividend, which it will start doing in the coming quarter. The decision that the publishers of the Dow take then should be of interest to analysts and investors alike.
There are also suggestions that Apple should go for a stock split, which would make it more eligible. The arguments may interest McGraw-Hill (MHP), the publishers of S&P 500, for taking a call on whether Apple should be in the Index or not.