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GE shareholders should rejoice about the Dow dropping the stock

CNBC logo CNBC 6/20/2018 Tae Kim


John Flannery, chief executive officer of GE.© Provided by CNBC John Flannery, chief executive officer of GE.

After more than a hundred years as a component in the Dow Jones industrial average, General Electric will be replaced by drugstore chain Walgreens Boots Alliance WBA next week.

But GE investors may take solace in the recent history of stock price out performance from the companies booted from the Dow.

On Tuesday David Blitzer, managing director and chairman of the index committee at S&P Dow Jones Indices, said in a statement adding Walgreens to the Dow Jones industrial average will make the index "more representative of the consumer and health-care sectors of the U.S. economy."

"Today's change to the (Dow Jones industrial average) will make the index a better measure of the economy and the stock market," Blitzer said.

The change will occur prior to the open on Tuesday, June 26.

Many will say this change by the index committee at S&P Dow Jones Indices, marks a passing of the baton. GE's industrial manufacturing days are over as the economy shifts to a more service orientation.

Time and time again, new trends replace old ones in the Dow. For example, take Cisco replacing General Motors in 2009 or Nike replacing Alcoa in 2013.

But this theory is not one to base your investing on, recent history shows.

"Lastly, while a negative in the near-term [for GE], we note that recent removals from the index have gone on to outperform the DJIA in the 12-months following the announcement," Goldman's Joe Ritchie said in a note to clients Tuesday.

The most recent removal before General Electric soundly outperformed the S&P 500 in the year after getting booted, according to CNBC data.

AT&T T shares rose 15 percent in the 12-months after it got replaced by Apple in the Dow versus the S&P 500's 2 percent decline in the same time period.

Alcoa's AA stock soared even higher with 96 percent return in the year after its exit.

a screenshot of a cell phone© Provided by CNBC

It seems that by the time the index committee acts to remove an underperforming stock, most of the fundamental deterioration is already priced into the shares and so you see a rebound.

GE shares fell as much as 3 percent in after hours trading following the decision Tuesday. After opening lower on Wednesday, the stock rebounded to near positive.

Investors initially sold off GE shares perhaps due to the recent Wall Street concern over retail shareholder sentiment.

Deutsche Bank's John Inch had warned in January that GE would likely be dropped from the Dow this year and that such a move would hurt its shares.

"We believe headline risk to be the most significant risk factor if GE were to be dropped from the Dow — potentially amplified by GE's high mix of retail investors (roughly 40% of GE's common stock is held by retail investors)," the analyst wrote.

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