By: Tim Bennett
26.06.2018
26.06.2018
The Dow Jones index has just ejected one of its oldest members, General Electric (GE). The key takeaway for investors is clear says Tim Bennett.
What GE’s demotion from the Dow Jones tells equity investors
The latest review of the illustrious US index, the Dow Jones 30, yielded quite a surprise. General Electric, (GE), a firm that has barely missed a year since the index was first formed, was kicked out to be replaced with Walgreen Boots. So here we take a quick look at what this demotion reveals and conclude that it says as much about the index as the fortunes of one of its longest-serving members.
What happened?
For over a century, GE has been one of America’s industrial stalwarts and, at many times over that period, one of its biggest companies. However, it has recently suffered a prolonged period of share price decline – at the point the list of members for the Dow Jones 30 was drawn up, a price of $12.95 put it outside the top tier.
Why a demotion?
Unlike many other indices, the Dow Jones ranks companies for inclusion by their share prices, not their size (market capitalisation). So, although GE remains one of America’s bigger companies, with a market capitalisation that surpasses some other members of the Dow Jones, its share price had fallen too far for it to remain in that group. At $12.95, it was far below other members such as Goldman Sachs ($228) and Apple ($186).
Does this matter?
Institutional investors, such as the big pension fund and life assurance companies, seemed to shrug off the news, which is why GE’s price reacted with a modest 1.5% drop when the demotion was announced. These days relatively little money tracks the Dow Jones – around $29bn, compared to more like $10trn for the S&P 500 index, which includes far more firms and is put together on the basis of market capitalisation.
The problem is that the media still quote the Dow Jones often and it still therefore perceived as being a reliable bellwether by many observers. Private investors must tread carefully here – this is in fact an index that covers the performance of relatively few stocks and that is constructed on a quirky basis in the context of most indices.
Conclusion
On the one hand, it is fair to say that GE is not the powerhouse it once was and has been struggling for some time compared to its former glory days. Some would even say that it is a business that belongs in the history books in 2018. However, the truth is that it is still America’s 44th largest firm by market capitalisation.
The danger is that a high-profile disappearance from a narrow index such as the Dow Jones could be interpreted as being worse than it actually is and may even lead some investors to panic-sell somewhat spuriously. My advice is to see the index from which it was ejected for what it is – a high profile anachronism.
