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Will Dow Jones Become The Last Buyer Of Apple?

Spring arrives in the northern hemisphere this month. Its appearance holds various connotations to different people, although my unscientific poll of a few random individuals leads me to believe the majority of the population has a positive bias toward its arrival. Daylight Savings Time has already kicked in, and soon winter's frozen landscapes thaw, daylight hours lengthen, flowers bloom, and the frequency of outdoor activities increases. Ah, spring time!

For baseball fans, the onset of spring signals that Opening Day is just around the corner. I used to live in Cincinnati, home of the first professional baseball team. Saying the residents of Cincinnati take Opening Day seriously is an understatement - it's officially a city holiday. For decades, perhaps even a century, the first pitch of every baseball season was thrown in Cincinnati. This tradition ended sometime in the 1980s when it was decided the first pitch honor should be "shared" with other teams and cities (or "rudely snatched away," as the locals say), but the annual festivities remain.

For fans of the Dow Jones Industrial Average, the spring of 2015 will mark the time when Apple (NASDAQ:AAPL) finally joined the lineup. The change was announced last Friday and will be implemented on March 19. "As the largest corporation in the world and a leader in technology, Apple is the clear choice for the Dow Jones industrial average," proclaimed David Blitzer, the managing director and chairman of the Dow Jones Index Committee.

My reaction was along the lines of "Really? They are just now getting around to adding Apple to the Dow?" Seems to me, Apple should have been "the clear choice" long before it became the largest corporation in the world with a market cap of more than $700 billion.

Apple became the largest technology company nearly five years ago in May 2010 when its stock market value surpassed that of Microsoft. Fifteen months later (August 2011), Apple became the largest corporation in the world as its value overtook that of Exxon Mobil. A year later, it went on to surpass Microsoft's former 1999 valuation, making Apple the largest corporation ever in the history of the world. Depending on which of these historical milestones you choose, the simple fact remains that Apple has been an extremely significant stock for a number of years.

The stated purpose of the Dow Jones Industrial Average is "to provide a clear, straightforward view of the stock market and, by extension, the U.S. economy." The venerable index is intended to represent a cross section of American industry, with emphasis on the leaders within each sector. Therefore, I agree that Apple belongs in the Dow. However, I disagree with the timing of its inclusion. There were ample opportunities before now to add Apple to the Dow. Some examples include becoming the largest technology company, surpassing half of the current Dow constituents in market cap, or becoming the largest corporation in the world. Wouldn't logic dictate that it should have been added years ago?

Unfortunately, Apple seems to be more the rule than the exception for the Dow. Back in 1999, Microsoft was the world's largest corporation. As noted above, it established a size milestone in 1999 that neither it nor any other stock could surpass for about thirteen years. Do you know when Microsoft was added to the Dow? You guessed it - 1999, after years of superior stock market performance and its value was at a peak.

Suppose you and I were tasked with the responsibility of creating a Too Late To The Party Index, the TLTTPI. The goal of this index would be to identify and select large capitalization stocks with a high probability of having their best days behind them. What criteria might we use in selecting constituents for our index? One condition might be that if a stock is the largest stock in the world for three consecutive years, it would be added since it can no longer improve upon its ranking. Another criterion might be to exclude stocks that have overtaken the capitalization of any other stock in their sector in the past two years, because that would signify they were still growing.

The TLTTPI, and its criteria, are meant to be a tongue-in-cheek exercise. However, when you look at the history of stocks being added to the Dow (IBM 1979, Intel 1999, Microsoft 1999, Goldman Sachs 2013, and Apple 2015), it almost appears it is using similar criteria. Granted, I could be accused of cherry-picking my examples here, but I think you get the point.

Given this history, investors are left wondering what criteria are used in selecting stocks for the Dow. Many are surprised to learn there is not a strict set of rules. Instead, a committee of humans selects the stocks. The same is true for the S&P 500 Index. Shocking, isn't it? The two most popular indexes in the world are not based on rules, but are "actively managed" by committee.

This is an important but often overlooked fact in the active versus passive debate. I can't help but chuckle when a passive investing proponent claims to always use index funds and would never consider using active management in any portion of their portfolio. However, whenever someone buys a fund tracking the S&P 500 or Dow, they are buying active management in a passive wrapper.

Keep this in mind the next time a prospective client claims not to believe in active management. Once they realize that even the Dow is actively managed, you can steer them toward a more reasonable approach to active management. With the Dow and the S&P, you get active management by a committee that is sometimes years behind the curve. With Flexible Plan Investments, you get active management that always strives to be disciplined and timely. Which bat do you want to be holding when the market throws its next pitch? Let's play ball!

All the best,