Today, it has been widely reported Bank of America (BAC -1.24%), will be removed from the Dow Jones Industrial Average beginning next week, but that announcement may not mean all bad things for investors.
In addition to Bank of America, Hewlett-Packard and Alcoa will also be removed from the ever-popular benchmark average. They will be replaced by two financial services companies, Visa and Goldman Sachs, as well as athletic outfitter Nike.
The history
The Dow Jones is a popular benchmark index to gauge how well the stock market is performing. Often displayed alongside the S&P 500 and NASDAQ Composite indices on nightly news programs, Internet homepages, and countless other places, it is one of the key barometers of what the market did that day.
Bank of America was added to the Dow in February of 2008 following its acquisition of Countrywide. In a call with reporters following the announcement, John Prestbo, editor of the Dow Jones indexes, stated, "We were underweight with financials. Financials have been a very fast growing market over the past years."
At that time, Bank of America joined Citigroup, JPMorgan Chase, AIG, and American Express as the financial services companies represented in the Dow.
The performance
While it was true the financial industry was rapidly growing, few anticipated what would happen the following year, as the financial industry that had in fact been "very fast growing," collapsed. In that one year, Bank of America saw its stock price fall 90%, the index tracking major bank performance fell 75%, and the Dow itself dropped almost 40%:
The future
The key question now becomes, what are investors to make of this news? Is this the final assurance that Bank of America is no longer the company it was once believed to be? In fact, I would argue it doesn't mean much at all to investors, and it perhaps could even be a good thing.
While being in the Dow is a badge of honor to many companies, it by no means indicates they are the 30 best companies for investors. Over the last 10 years, the Dow is up 59.6%, and the S&P 500 is up 64.5%. And as it relates to individual stocks, the price of a company and its inherent value is contingent on its ability to generate profits that can be distributed to investors, not what index tracks it.
For Bank of America, its exclusion from the Dow may even be a good thing, as it marks the start of a new chapter for the bank. It should by no means impact the bank's future earnings potential.
According to Motley Fool banking analyst and author of the Fool's new report on picking great bank stocks, David Hanson, "Bank of America's time in the Dow was marked by misstep after misstep, but the bank appears to be well-positioned and focused to produce earnings more similar to the likes of JPMorgan Chase and Wells Fargo."
