Cutting GE keeps the Dow relevant and fit

Utilities company less relevant in modern economy

For longer than any living person can remember, General Electric has been an icon of corporate America.

The company survived the Great Depression, numerous recessions and wars, managing not just to hang on, but thrive amid the considerable change, tumult and innovation of the past century.

But GE couldn’t survive a stretch of poor profitability over the past several years, and was finally removed June 26 as a member of the Dow Jones Industrial Average, the stock market’s most recognizable barometer.

GE’s ouster is largely symbolic. Investors still can buy the company’s shares directly, and they continue to be included in market benchmarks such as the Standard & Poor’s 500 and Russell 1000 indexes. Many people still hold GE shares through S&P 500-based mutual funds and exchange-traded funds, in 401(k)-style retirement accounts and elsewhere.

But the transition reveals a lot about the company’s recent struggles and diminished role in an ever-changing economy. It also says something about how the Dow compares to other market benchmarks, especially the S&P 500.

Originally founded by Thomas Edison, General Electric was one of the 12 original members of the Dow Jones Industrial Average when the latter was launched in 1896. The original mix was filled with commodity and manufacturing companies, which dominated the economy back then.

The list included long-forgotten entities such as American Cotton Oil,

American Sugar, Distilling & Cattle Feeding and U.S. Leather.

Eventually, nearly all of those original companies, and many others in their wake, went out of business, got broken up, rebranded themselves or merged with or into other corporations. As time passed, their relevance and impact faded.

But GE hung on and went through various periods of renaissance and rejuvenation, reaching a zenith under former CEO Jack Welch.

Over a 20-year tenure, he took the company’s annual revenue from around $30 billion to $130 billion. While profits surged, GE became the world’s most valuable corporation with a stock-market capitalization or worth above $400 billion.

Even today, GE remains a major company with considerable clout. But for the first time in a century, it’s no longer considered elite.

GE’s revenue has stagnated recently; cash flow has slowed, and an $8.2 billion profit in 2016 turned into a $6.2 billion loss last year. Market cap has slipped below $120 billion. Jeffrey Immelt stepped down as CEO last summer.

The company cut its dividend in half and has aggressively sold off businesses — appliances, financial services, health care and oil services. Its new, streamlined focus is on aviation, power and renewable energy.

“The company has been kicked out of the globe’s most venerable equity benchmark, its stock price has badly underperformed against peers, its dividends are being cut, and it struggles with too much debt,” wrote ETFGuide.com chief portfolio strategist Ron DeLegge, who in a commentary said GE no longer fits the definition of a blue-chip company.

So S&P Dow Jones Indices, which oversees the 30-stock Dow Jones Industrial Average, decided to replace GE with Walgreens Boots Alliance, the pharmacy-focused health products retailer.

“Today’s change to the DJIA will make the index a better measure of the economy and the stock market,” said David Blitzer, a managing director at S&P Dow Jones Indices, in a prepared statement.

“The U.S. economy has changed: consumer, finance, health care and technology companies are more prominent today and the relative importance of industrial companies is less.”

The decision certainly can be justified.

GE recently accounted for a mere 0.5 percent of the overall performance or weighting of the Dow.

Compare that to Boeing, which was recently near 10 percent, United Healthcare (7 percent) or Goldman Sachs (6 percent). Home Depot, 3M, McDonalds and Apple each weighed in above 5 percent.

Compared to the S&P 500, which includes most of the largest 500 companies in terms of stock-market value — and uses size as the main cutoff — there’s much more discretion as to which companies get chosen to be in the Dow 30.

A committee of five people — three from S&P Dow Jones Indices and two from The Wall Street Journal — makes those decisions.

Like stocks included in the S&P 500, the Dow 30 stocks also are large, but the criteria for inclusion are more subjective. These companies are supposed to have an excellent reputation, a record of sustained growth and wide investor appeal.

The 30 stocks also have been selected to give the Dow a mix in various industries.

In short, the decision makers at Dow Jones Indices can and do cherry pick the stocks they want to include, and they occasionally pull out weeds. Other companies cut from the Dow in recent years include General Motors, Kraft Foods, Alcoa and Hewlett-Packard.

The Dow 30 and S&P 500 actually have performed fairly similarly over the years, at least as well as you could expect given that one basket has 30 stocks and the other 500.

That’s because there’s much overlap, with most of the 30 Dow stocks represented among the top S&P 500 components.

The Dow actually outperformed the S&P 500 index by about 0.5 percent annually on average over the past decade, despite a drop of 55 percent in the value of GE shares from the end of 2016 through May 2018.

So the decision to remove a struggling General Electric and replace it with Walgreens wasn’t just about GE.

It also was about keeping the Dow Jones Industrial Average fit, healthy and relevant.