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Did The Dow Really Need A Drug Store Retailer In Place Of GE?

By (Clement Thibault/ MarketsJun 21, 2018 04:04
Did The Dow Really Need A Drug Store Retailer In Place Of GE?
By (Clement Thibault/   |  Jun 21, 2018 04:04
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The Dow committee ejected General Electric (NYSE:GE) from the 30 component mega cap index, replacing it with Walgreens Boots Alliance (NASDAQ:WBA), a retail pharmacy chain. What's surprising isn't the event itself—we called that the day before the announcement—but rather the committee's startling and very unexpected substitute.

In a statement issued with the announcement on Tuesday, David Blitzer, the committee chairman said the "change to the DJIA will make the index a better measure of the economy and the stock market," adding, "the DJIA will be more representative of the consumer and health care sectors of the U.S. economy." But the health care sector is not exactly missing among the Dow components, nor are retailers.

Is a drug store chain really the right replacement for the once mighty multinational conglomerate? Perhaps more puzzling, does it appropriately represent the current state of the US economy and the variety of companies traded on the broader stock market?

Among health care sector stocks on the Dow there's Johnson and Johnson (NYSE:JNJ), Merck (NYSE:MRK), Pfizer (NYSE:PFE), and UnitedHealth (NYSE:UNH). Consumer/Retail stocks are well represented too. There's Coca-Cola (NYSE:KO), McDonald's (NYSE:MCD), Walmart (NYSE:WMT), Nike (NYSE:NKE), and Home Depot (NYSE:HD). Some companies, like Procter & Gamble (NYSE:PG), fit into both categories.

Some might say the choice was predicated on recent merger and acquisition activity that's gripped US markets. Walgreens Boots Alliance, with a current market cap of $63.62 billion, represents the successful merger of two companies whose holding company began trading in the US on the very last day of 2014. This may be why they opted not to include the larger CVS Health (NYSE:CVS).

The latter is currently involved in a messy, ongoing deal to merge with Aetna (NYSE:AET), which is running up against strong opposition from the American Medical Association. CVS, with a $71.95 billion market cap and shares trading at $71.60, makes more sense from a weighting perspective. But the merger uncertainty makes it the wrong choice for the Dow committee which looks for company stability.

Still, does this addition better position the Dow to represent the 21st century American economy? We don't think so.

Adding yet more retail, a sector that's had struggled quiet a bit in the new economy, doesn't prepare the Dow for the future. One would have expected the Dow to use this opportunity to make a great leap forward. Instead, it merely shifted the highly watched index from representing the 'very old' US manufacturing economy to something a little less old. Call it the mid-to-late 20th century economy.

WBA Weekly 2015-2018
WBA Weekly 2015-2018

Walgreens resumed revenue growth during the past two quarters as the entire retail space recovered, after a year of stagnation in 2017. Still, its bottom line declined over the past two years, only stabilizing in the first two quarters of its fiscal 2018 (September-August). No growth there, so far. And shares have been slipping overall, irrespective of the fact that the stock has gone up a bit since the announcement.

Given how robust the US's technology sector has been over the past decade, as well as its large and still growing presence within the American economy—it now accounts for about 25% of the S&P 500's total market cap—wouldn't it have made more sense to choose something that would more accurately balance the Dow 30 weighting?

Though Apple (NASDAQ:AAPL), IBM (NYSE:IBM), Intel (NASDAQ:INTC) and Microsoft (NASDAQ:MSFT) are all Dow components, those four technology stocks combined have a weighting of just 13.5% in the Dow. Balancing the index to appropriately mirror the direction the US's economy is headed would have called for more technology shares to be included.

Historically the Dow committee has been known for its conservative choices, so perhaps a drug store chain isn't that surprising a choice. Nevertheless, if the American economy is evolving, remaining overly conservative could mean being left behind.

Right now, with Pfizer trading at $36.5, making it the index's cheapest stock, but with a hefty market cap of $211.87 billion, there are no immediate candidates that might next be rolled off the Dow. If the committee really wants to truly reflect the broader US equity market and the country's economy they'll have to come up with a more creative solution.

Did The Dow Really Need A Drug Store Retailer In Place Of GE?

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Did The Dow Really Need A Drug Store Retailer In Place Of GE?

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Brad Smith
Brad Smith Jun 21, 2018 19:12
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Clement, congrats on your prediction of GE getting ejected from the Dow. I think the WBA pick has bypassed quite a few predictions. Not many saw it coming especially since it has not been doing all that well and there are many better candidates.
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