What DJIA Changes Mean For GE, Walgreens Investors

After the initial shock of S&P Dow Jones Indices booting General Electric Company GE from the Dow Jones Industrial Average in favor of Walgreens Boots Alliance Inc WBA, traders are now asking what the move could mean for the two stocks and just how relevant the DJIA is in today’s market.

The Dow’s Usefulness

Dow critics argue that the S&P 500, which is market cap-weighted and has 500 components, is a more accurate reflection of the U.S. market than the Dow, which is price-weighted and has just 30 components. Despite their differences, the DJIA and the S&P 500 have nearly perfect correlation going back to the 1950s — making it hard to argue one index is objectively “better” than the other.

As All Star Charts recently pointed out, the fewer components in the Dow can also make it easier to identify outliers, which can be extremely useful to traders. The Dow stocks are all massive companies, so if one or two stocks are trending counter to the other 28 or 29 components, it could be an indication of broader sector rotation.

Expert Weighs In

All Star Charts analyst Tom Bruni appeared on Benzinga’s PreMarket Prep show this week to weigh in on the Dow's usefulness. 

“We realize that a lot of people don’t have the time to go through the entire S&P 500,” Bruni said. “If you want to simplify it, you can get the exact same benefit with about 30 stocks, and it only takes an hour or an hour and a half to do that.”

Bruni said it doesn’t necessarily bother him that the Dow is price-weighted and that some of its components have much more influence on the index than others.

“We try to take a weight of the evidence approach, and due to the correlation with the S&P 500, whether or not they move the exact same percentage [in the near-term] is not what we’re concerned with."

The Outlook For Impacted Stocks

While philosophical discussions about the usefulness of the Dow are certainly interesting, GE and Walgreens investors want to know how entry and exit from the Dow can impact stock prices.

Here’s a look at how the last four stocks dropped from the Dow performed in the six months following the move:

• AT&T Inc. T (March 12, 2015): down 1.2 percent.
• Alcoa Corp AA (Sept. 23, 2013): up 45 percent.
• Bank of America Corp BAC (Sept. 23, 2013): up 24.1 percent.
• HP Inc HPQ (Sept. 23, 2013): up 50.7 percent.

And here’s a look at how their four replacements fared over the same stretch:

• Apple, Inc AAPL (March 12, 2015): down 8.2 percent.
• Goldman Sachs Group Inc GS (Sept. 23, 2013): up 1 percent.
• Nike Inc NKE (Sept. 23, 2013): up 9 percent.
• Visa Inc V (Sept. 23, 2013): up 13.8 percent.

Surprisingly, each of the four stocks booted from the Dow has outperformed their replacement. The last four stocks added to the Dow have averaged a 3.9-percent gain during their first six months in the Dow, while stocks that were removed averaged a 29.6-percent gain during their first six months out.

Related Links:

Why GE's Removal From The Dow Could Help Investors

What Does GE Mean To The Entire Stock Market?

Photo by Bubba73/Wikimedia.