It’s official: General Electric Company (NYSE: GE), one of the great giants of 20th century American industry, has been booted from the Dow Jones industrial average.
GE was the only remaining member of the original DJIA of 1896, when the blue-chip average consisted of just 12 industrial companies. It was also the longest continuous member of the Dow, with a 111-year streak that began in 1907.
Alas, all good things must come to an end. GE found it harder to adapt to the ever-changing world of the 21st century. It will be replaced by Walgreen Boots Alliance ( WBA) on June 26.
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How did such a storied and dominant company get to this point? And, perhaps more importantly, what needs to happen for GE to return to the Dow?
How we got here. First, it’s important to know that the General Electric of 2018 is by no means an irrelevant has-been. It’s still worth a robust $110 billion or so — far more than the $67 billion drugstore chain taking its place.
What’s undisputable, however, is GE’s steadily waning influence. As recently as the year 2000, it was the most valuable public company in the U.S., with a market capitalization approaching $600 billion.
Few could’ve imagined that it would take just 18 years for GE to lose its Dow membership, something that had become a fundamental part of its identity.
Truthfully though, GE worked hard to forget its core identity as a best-in-class industrial company, consciously building a massive financial business in the name of diversification.
Then the 2008-2009 crisis happened, nearly crippling the entire firm.
“Since then, GE has worked hard to dismantle the financial business to leave a solid industrial business behind,” says Andy Kapyrin, director of research for RegentAtlantic, a New Jersey-based asset manager with $3 billion in assets under management. “It turns out, the industrial business’s health was just a veneer. It’s fundamentally troubled, in spite of being in business lines with solid underlying growth.”
In recent years, the company tried to get back to its fundamentals, spinning off its consumer finance division Synchrony Financial ( SYF) and selling the vast majority of its GE Capital business. Gone were the large real estate portfolios, commercial lending, banking and other financing businesses.
Today though, GE’s Power and Oil & Gas segments are really struggling. Within the last year, the company’s brought in a new CEO and even slashed its dividend — a cardinal sin on Wall Street.
The lousy recent showing in its underlying business has led to bad PR — and horrendous share performance, with GE stock down 55 percent in the last year. The combination of bad fundamentals and performance was enough to get the company banished from the prestigious Dow Jones industrial average.
“The Dow is a price-weighted index, and a company with a low stock price doesn’t move the needle on the index anymore,” Kapyrin says. GE had become an ornament — and an ugly one — on an otherwise pretty tree.
Could GE return to the Dow? “I do not view GE returning to the DJIA as being very likely to occur within the next five years,” says Tom Arnold, professor of finance at University of Richmond’s Robins School of Business. “In theory, GE could return to the DJIA if the industries it chooses to follow in the future have a significant impact on the economy and/or become more representative of the economic landscape.”
Once the largest company in the U.S., General Electric now trails both Boeing Co. ( BA) and 3M ( MMM) in market cap amongst industrials — each of which already represent that sector in the Dow themselves.
In fact, the changing economic landscape in America was cited as one reason Walgreens will replace GE. WBA is a unique mix of the consumer and health care sectors, two increasingly important areas. (It doesn’t hurt that its shares go for $67, making it five times more able to move the price-weighted Dow than GE at $13.)
Although the 12th largest company by value in the Dow, GE’s low share price made it essentially irrelevant to the Dow’s daily moves. It was the lowest weighted of all 30 companies, accounting for just 0.36 percent of the average.
Cynically speaking, if GE wants to return to the vaunted blue-chip average, a reverse share split — which increases the price of each share by a proportional reduction in the number of shares outstanding — would go a long way.
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Unfortunately though, it’s not that simple. There’s a committee that oversees Dow membership, and it’d be naïve to think they don’t take prestige into account. Consider the 2015 addition of Apple ( AAPL) to the Dow.
“At the time, Apple looked like it was a world-leading company while AT&T ( T) had lost its innovative edge,” says Peter Cohan, lecturer of strategy at Babson College. “If GE regained that edge — as evidenced by double digit revenue and profit growth — it might be considered a good company to add back to the Dow.”
Not a death knell. Of course, there is no switch that says “thrive again” that one can flip.
“There are no Hail Mary passes for GE. Turning around a ship this big requires planning, divestitures and cost cutting,” Kapyrin says. “The biggest thing it requires is time.”
The new management at General Electric is aware of the problems. CEO John Flannery has targeted $2 billion of certain cost cuts in 2018, $805 million of which GE accomplished in the first quarter. It’s planning $20 billion in dispositions by the end of 2019, and may even sell its iconic but underperforming lighting business.
The Dow doesn’t tend to manically add and remove components, but it happens every few years. It’ll likely be at least five years, and probably closer to a decade on the short end, before GE even has a chance of returning. But it’s not unheard of: Chevron Corp. ( CVX) and even GE itself have each been removed from the index only to be added back later. Chevron’s absence lasted eight years, while GE stock, at the turn of the 20th century, was gone nine.
That said, the job of GE’s management is to do well for shareholders, not vie to become a member of the most arbitrary measure of equities on earth.
There is little practical importance to being a Dow member; under $30 billion of mutual and exchange-traded funds tracked it at the close of 2017, compared to $9.9 trillion tied to the S&P 500 index, according to S&P Dow Jones Indices data.
[See: 7 of the Best Stocks to Buy for 2018.]
Moreover, company reorganizations can often be fruitful for shareholders. Spin-offs, divestitures, cost-cutting and other measures can end up refocusing the company on what it does best, creating long-term value for investors and de-risking the company.
The only question is: What exactly does GE do best? At 126 years young, it’s about time to decide what General Electric wants to be when it grows up (or shrinks down).
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Can General Electric Company (GE) Ever Return to the Dow? originally appeared on usnews.com
