Classic Entertainment
June 25, 2018
I love to watch old black and white film classics. Early Bogart or Jimmy Stewart movies have really stood the test of time. I am a sucker for financial classics too. They provide a surprising amount of entertainment.
The first time Charles Dow, and his statistician Edward Jones, calculated the Dow Jones Industrial Average (DJIA) was May 26, 1896. The 12 original component companies included names like American Cotton Oil Company, United States Rubber Company, National Lead Company, and American Tobacco Company. The initial DJIA value was 62.76.
Hard as it is to imagine now, America would have been viewed as an emerging market economy when the DJIA was first calculated. The incredible success of the US economy since 1896 has been the driving force behind the rise of the DJIA to today’s value of over 24,500! The modern notion of socially responsible investing was as remote for Messrs. Dow and Jones as the idea of color motion pictures. It was simply inconceivable at the time.
General Electric is the only modern company to have been a part of the index at the beginning. GE was out of the index for a time, but has been a continuous component since 1907. This past week, however, the index committee announced that GE was being replaced by Walgreens Boots Alliance. The change will take place this week.
GE has struggled recently and its share price has fallen to the low teens from over $30 in late 2016. New management is pursuing a restructuring strategy and investors have yet to be convinced the new plan will deliver the goods.
The Dow is a price weighted index as opposed to a market capitalization weighted index like the S&P 500, for example. This means that high priced shares have a disproportionate impact on the index relative to low priced shares. Dow component Boeing trades around $339 a share, for example, as opposed to GE which currently trades around $13. A one percent move in Boeing would have 25 times the impact of a one percent move in GE. In that light, it’s not surprising that GE is being replaced in the index.
Getting booted from the Dow is not always the curse it might seem. When AT&T was replaced by Apple, it gained 15% in the following year. When Hewlett-Packard was replaced by Visa, it gained 73% over the next year. When Alcoa was replaced by Nike, it gained 96% over the next twelve months.
As we all know, past performance is no guarantee of future success. That said, I’m sure a year of outsized performance is just the kind of movie the team at GE would like to see. As always, it will be interesting to see how things play out this time around.
Mike Masters
