It would be so easy — and so much fun — to mock poor, bedraggled General Electric for getting booted out of the Dow Jones industrial average after its 111-year stay and being replaced by the Walgreens Boots Alliance drugstore chain.
GE, of course, has been troubled for years. Its stock has fallen sharply recently, and its reputation as a well-run company — which in hindsight, it didn’t deserve — is in tatters. As are people who bet heavily on GE stock.
But instead of joining the GE’s-a-mess crowd, let’s look at what GE’s ouster from the Dow actually means. Which is almost nothing.
That’s because although the Dow matters a lot to ordinary people, who have grown up hearing about the Dow every day that financial markets are open, the Dow is less than an afterthought to big-time Wall Street types and money managers.
Here’s why: The Dow is an average that’s based on the share prices of its components. People often call it an index, but it’s an average. You add up the stock prices of the 30 stocks, run the total through something called the Dow Divisor (which I’ll discuss another day), and — voilà — you get the Dow average.
By contrast, the Standard & Poor’s 500-stock index and the various total stock market indexes in which people invest through mutual funds are based on companies’ stock market values, not their share prices.
That distinction between market value and share price is why trillions of dollars of investments are tied to the S&P and total market indexes, and virtually nothing is linked to the Dow. Total market value matters. Share prices, as we’ll see in a bit, can be sort of random.
The reason GE became a Dow dumpee is that its share price, which was $12.95 at Tuesday’s market close, was an insignificant factor in the Dow, whose share prices totaled $3,587.31.
However, when it comes to the real financial world rather than Dow World, GE, with a stock market value of about $110 billion, has more impact than at least five companies that aren’t being kicked out of the Dow: Travelers, American Express, Caterpillar, Goldman Sachs and United Technologies.
For that matter, GE’s stock market value is substantially higher than that of Walgreens, the company replacing it in the Dow.
But when it comes to share price, as opposed to stock market value, GE isn’t in the same league as the other Dow stocks. GE’s share price, about $13 when last I looked, was less than a fifth of the $67.50 that Walgreens shares were fetching. In fact, GE’s share price was less than half that of the Dow’s second-lowest-priced stock, Pfizer.
But when all you look at is share price, neglecting market value, you end up with distortions — which is why I have little respect for the Dow, and why you should have little respect for it, too.
For instance, GE’s market value is about triple that of Travelers, the Dow’s lowest-valued component. But Travelers’ stock price, about $125, is more than nine times GE’s price.
In the Dow, a $1 (less than 1 percent) move in Travelers stock has the same weight as a $1 (8 percent) move in GE’s stock. But in the real world, a $1 move changes GE’s market value by $8.7 billion, more than 30 times the $270 million impact that a $1 move has on Travelers.
The reason the Dow is an average, of course, is that when it was launched in 1896, the only way to get a timely number for the Dow’s value was to add up the stock prices of its components and divide by the number of components.
Now, with vast computing power in the world, calculating second-to-second changes in the value of a 500-stock index — or even a multi-thousand-stock index — is child’s play. (At least for children who, unlike me, don’t have fat fingers when it comes to using a computer.)
Now, let me show you one last strange thing.
Had GE really, really, really wanted to stay in the Dow, it could have done a 1-for-10 reverse split of its stock. That would have left it with about 870 million shares outstanding, rather than 8.7 billion — and its stock price would have been about $130, rather than about $13. Its stock market value, however, would have been unchanged.
At $130, GE’s share price would have accounted for about 3.5 percent of the total Dow prices (adjusted for the reverse split) as of Tuesday’s close, rather than its actual 0.36 of 1 percent.
I can’t imagine a $130-per-share GE getting kicked out of the Dow. But kicking out a $13 GE, which had virtually no influence on the average, was an easy call. Symbolism over substance. And that, my friends, is the bottom line.