GE And The Way Of The Dow

By Brian O'Connell

General Electric is out and Walgreens is in as two major U.S. corporate brands trade places – and perhaps reputations -- on the Dow Jones Industrial Average Index.

Even though GE has been in the index since it was formed and even represented corporate America once, its fortunes faded as times changed. The company’s price was dropping and its balance sheet was thinning. Basically, GE was no longer a broad indicator that Dow Jones looks for in an index company.

What does that mean for GE and for the Dow? Perhaps a whole new world where both of them don’t have the sway they once did. But the move is more evolution than revolution.

“The delisting from the Dow is a powerful symbol of GE's decline. However, it isn’t the end of its world,” said Peter Cohan, professor of strategy, management, and entrepreneurship at Babson College. “A very small proportion of money from investors goes into the Dow Jones, so it's not going to affect their ability to attract capital, and it will have no effect on their operations.”

Even so, being booted from the Dow isn’t a good look for GE. The company was an original member of the Dow 30, and continuously a member since 1907.

“Removing it from the Dow isn’t going to materially impact the performance of the index, as the firm only represented 0.37 percent of the index,” said Robert Johnson, principal at the Fed Policy Investment Research Group. “That said, it’s an indication of how far GE has fallen from the pantheon of U.S. companies.”

Where Do GE Investors Go?

The larger question for GE investors is a simple one – what now?

Company decision makers need to change course, and focus on the basics, Cohan said, a move the company has been reluctant to make in recent years.

In July 2007, Cohan recommended that GE exit businesses where it was not a leader, “such as media, financial services, appliances, and lighting.”

“Well, they’re still in the lighting business and they're still in financial services which are major drags on their business,” Cohan said, “so they still have some ways to go to get their business fixed.”

In the meantime, Cohan is holding on to his GE shares. Is it feasible that GE could one day return to the Dow?

“Yes, it’s possible if the committee that makes these decisions opts to restore GE to the Dow,” Cohan said. “I am not sure what criteria are used, but if you look at the reason that GE was dumped and Walgreen's added you can get an idea.”

The move was made to make the Dow more representative of the consumer and health care sectors of the U.S. economy, Dow officials said.

“The U.S. economy has changed,” said David Blitzer, managing director and chairman of the index committee at S&P Dow Jones Indices. “Consumer, finance, health care and technology companies are more prominent today and the relative importance of industrial companies is less.”

The swap “will make the index a better measure of the economy and the stock market,” he added.

It’s not totally clear what Dow officials are looking for, Cohan said, but he does “take a hint” from the 2015 decision to replace AT&T with Apple.

“At the time, Apple looked like it was a world-leading company while AT&T had lost its innovative edge,” he said. “So perhaps if GE regained that edge -- as evidenced by double digit revenue and profit growth -- it might be considered a good company to add back to the Dow.”

'An Artifact From An Earlier Era'

It’s not just GE that’s drawing the ire of Wall Street observers after the GE downgrade –it’s the Dow Index itself.

“The Dow 30 itself is really just an artifact of an earlier era, one in which a recently industrialized America was first taking its place among the world's great economic powers,” said Larry Elkin, president of Palisades Hudson Financial Group in Fort Lauderdale. “Today, the financial news media still breathlessly reports daily movements in the index, and every time it hits a big round number it is treated as some sort of historic event.”

Elkin said some clients care about the index but he called it overhyped and meaningless among his peers.

“The Wall Street Journal, whose editors sit on the committee that decides the Dow's membership, reported that less than $30 billion sits in index funds designed to track these 30 stocks,” he said. “That's a rounding error compared to nearly $10 trillion that tracks the more representative S&P 500 index.”

Johnson of the Federal Policy Investment Research Group said Dow Jones can modernize the index by moving away from its price-weighted model.

“It is a price-weighted index, meaning that lower-priced stocks — of which GE is one — have a much lower weight than higher-priced stocks,” Johnson said. “The concept of price-weighted is anachronistic and was initiated to make it easy to compute the index value.”

When the Dow was 12 firms, you simply added up the prices and divided by 12, Johnson added.

“Now, most indexes are market cap-weighted,” he said, “meaning a company that has 10 times the market cap of another company has 10 times the weight.”

Brian O'Connell is a former Wall Street bond trader, and author of the best-selling books, The 401k Millionaire and CNBC's Guide to Creating Wealth. He's a regular contributor to major media business platforms. Brian may be contacted at [email protected].