If Deutsche Bank is right, the DJIA will lose one of its original “Industrial” founding members, which has been in the index since 1907.
General Electric has been an original component of the Dow Jones Industrial Average (DJIA) index – which was invented by Charles Dow in 1896 – for over 110 years. It may not be there for long, however: in a note from DB’s John Inch, the analyst writes that he “believes the chances that GE could be removed from the Dow are increasing as GE continues to face substantial challenges including earnings and cash pressure, tough global power generation markets, aggressive downsizing, shrinking its portfolio, management shake-up and SEC investigations.”
How would the expulsion take place? Deutsche explains:
The Dow is managed by committee (a part of S&P Global) that meets twice a year in secret to review (and potentially make changes) to the component companies. The index is intended to represent the “best” large companies in the US. The index is not market cap weighted but weighted by absolute share price. Consequently, apart from GE’s other challenges, as the company’s absolute share price has continued to drop (and as the share prices of the other companies have been increasing), GE increasingly falls into the category of outlier and consequently a likely candidate for removal, in our opinion.
In addition, the committee reportedly prefers for the Dow to incur no more than a 10:1 ratio between the component companies’ highest share price and lowest share price. Currently, the ratio between Boeing (the highest) and GE (the lowest) exceeds 20:1. Additionally, GE’s weighing in the Dow is 0.4%: the lowest on record and making it a member of the index only in the loosest sense. By comparison, Boeing is 8.92%.
In September 2003, the last major Dow shuffle removed American Airlines, Bank of America and Hewlett Packard and added Goldman Sachs, Nike and Verizon. The share price average of the 3 stocks that left was $15 vs. $134.50 for the 3 stocks that were added.
Furthermore, if GE were to be removed from the Dow, the company does not have to be replaced with an industrial company. For instance, Honeywell and Altria were replaced with Bank of America and Chevron in early 2008.
This also means that the DJIA is only an “industrial” average in the loosest term of the world now.
We believe headline risk to be the most significant risk factor if GE were to be dropped from the Dow – potentially amplified by GE’s high mix of retail investors (roughly 40% of GE’s common stock is held by retail investors).
Finally, one look at GE’s chart relative to the Dow shows why its expulsion from the DJIA is now just a matter of time.