What about Amazon? Dow Industrials Dumping GE for Walgreens reflects the index dilemma

The Dow Jones Industrial Average has driven out numerous major industrial companies in the last decade, including mining


Westinghouse Electric Corp. and this week

General Energy

GE -0.54%

in an effort to adapt a 19th century index to a 21st century economy.

That path has become increasingly tense, partly due to the limitations of how the index is constructed.

Critics also argue that the index selection committee has been eliminating troubled companies to avoid undermining the long-term performance of the average.

"Honestly, I did not like the move"

Robert Pavlik,

Senior portfolio manager and chief investment strategist at SlateStone Wealth, said about the decision to leave GE. "It's supposed to be an industrial average that reflects the general economy of the United States, and if that's the case, why replace it with a Walgreens?"

Stocks of Dow components are selected by the index committee, a group that includes publishers of The Wall Street Journal, which is published by Dow Jones & Co., a part of

News Corp

Exchanges of previous components in the index tended to highlight a particular company that had disrupted entire industries and redesigned consumer behavior, such as

Visa Inc



, or tried to maintain a balance with a peer-to-peer replacement.

In 2015,

AT & T

was replaced by


that had revolutionized the technology and communications industries with their iPhone and other mobile devices. Two years before that, the index committee eliminated

Bank of America

, who was still struggling under the weight of the 2008 financial crisis, for a healthier life

Goldman Sachs Group

whereas Alcoa was replaced by a house of machines of athletic clothing


The addition of Walgreens, however, has baffled some investors. The large retailer is part of the basic consumer sector of the stock market, which has had problems under the shadow of

Inc. & # 39; s

e-commerce skills

"When you think about the direction in which the economy is headed, and even the names that dominate the market today, you are not looking at a pharmacy retailer that could be greatly threatened by Amazon.," He said.

Michael O & # 39; Rourke,

Chief Market Strategist at JonesTrading. "If you want to be representative of the economy and where the economy is going, you have to add them."

But its omission reflects the limitations of the Dow methodology.

Since the creation of the index by Charles Dow, founding editor of the magazine, the average has been weighted by the price, that is, the higher the price of the shares, the greater the influence of a particular component, and vice versa. So


which is quoted at $ 342.69 per share, has an influence 27 times greater than GE at around $ 12.88 per share. That's different from the indices like the S & P 500, which are weighted by the market capitalizations of the components.

Although GE fell 45% last year, it barely made a dent in the index. Meanwhile, Caterpillar has been one of the main actions to help raise the index despite having a smaller market limit than the problematic conglomerate.

The price of Amazon shares, currently around $ 1,750 per share, would cause enormous turbulence day by day. in the Dow. If the company were in the Dow on Wednesday, its increase of less than 1% would have contributed approximately 105 points to the Dow, which fell only 42 points during the session.

With Walgreens, the basic consumption shares have four representatives in the market. Dow, the same amount of discretionary shares, financial firms, health care companies and industrial companies once GE was removed, a more equitable level in the sectoral lines than in the S & P 500, which gives its highest weight to industrial, technological and financial companies.

Given the uncertain future of the sector, Walgreens could follow the path of other Dow components that entered and left the index quite briefly due to their decreasing size or turbulence within the companies. Kraft Foods spent nearly four years on the index before it was eliminated in 2012 after the spin-off of its grocery business in North America, in favor of


Bank of America received five years.

The elimination of businesses with problems seems to have helped keep the index on the rise. The indexing committee made changes in the Dow for eight separate years since 1998, and the index ended up posting positive returns in six of those years.

Not all investors believe that the elimination of GE from the index consolidates its status as a low-yield stock. In fact, the most recent decision of the S & P Dow Jones Indices makes some investors feel more optimistic about GE's rebound probabilities.

Returning to 1972, stocks that have been eliminated from the Dow have tended to outperform over time, with companies surpbading the blue-chip index by an average of 9.2% over the next 12 months, according to an badysis of Ned Davis Research.

For some investors and badysts, the trend suggests that the index committee behind the Dow industrials will often make their decisions, eliminate a company before it has had a chance to turn around.

Analysts predict that GE shares will increase in the short term, with the objective of average price for shares of $ 16.42, according to FactSet, 27% over its current price.

"It's definitely going to be a name that's on my radar," Pavlik said. "When they expel him from the Dow, I think he highlights that he's probably close to his bottom."

Write to Michael Wursthorn at [email protected] and Akane Otani at akane.otani @ wsj.com

Appeared in the print edition of June 21, 2018 as & # 39 In GE hits, Dow & # 39; s Limits Stand Out & # 39;


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