The Dow Jones Industrial Average (^DJI 0.18%) is one of the most-followed market benchmarks in the investing world. The 30 stocks that make up the Dow are the cream of the crop in nearly every industry in the stock market, with only transportation and utility stocks left out to form their own averages.
Yet occasionally, the overseers of the Dow decide that it's time to make a shift and replace one Dow component with another. Lately, a lot of speculation has swirled over whether General Electric (GE 0.31%) should get booted out of the average. Despite more than a century in the index as one of the Dow's founding stocks, it's likely that GE's days in the Dow are numbered, and it's interesting to think about what companies might take the industrial conglomerate's place.
Image source: General Electric.
The challenge with General Electric
General Electric's business problems have been well documented. Despite solid performance for some areas, such as aerospace and healthcare, poor performance in its energy and power segments have held back the industrial giant's overall results. That has led to massive share-price losses at GE, falling 45% in 2017 and more than 20% so far in 2018.
GE still has a market capitalization of almost $120 billion, so the company's size wouldn't be a problem if the Dow were a market-cap weighted index. However, the Dow Jones Industrials use a price-weighted system for calculating the level of the benchmark, and that makes it more important for its components to have somewhat similar share prices. General Electric's sluggish performance throughout the past decade and its subsequent slide over the past year and a half have left it with a share price below $14. That's barely 4% of the price of the most expensive stock in the Dow, meaning that GE has 25 times less weight in determining changes in the Dow than the average's most influential stock.
What could replace GE in the Dow?
If the overseers of the Dow Jones Industrials decide to kick General Electric out, they'll need a replacement. They'll have several options in doing so, but none of them offer a perfect solution.
One idea is to look at the biggest companies in the stock market that aren't part of the Dow. Right now, that would likely involve adding another technology company to the average, since Alphabet (GOOG 3.25%) (GOOGL 3.85%), Amazon.com (AMZN 1.45%), and Facebook (FB 1.91%) are among the highest-valued stocks outside the Dow right now. Of those, Alphabet and Amazon face the obstacle of share prices that exceed $1,000, making them inappropriate for the price-weighted average. Amazon or Alphabet would likely have to do a stock split to gain admittance into the Dow. Meanwhile, Facebook's share price is quite reasonable. Yet from a more general standpoint, some will balk at adding another tech giant to a list that already includes five key stocks in the sector.
Another possibility would be Berkshire Hathaway (NYSE: BRK-A) (NYSE: BRK-B). The Buffett-led conglomerate has a history of investing in General Electric and other industrial stocks, and its B share price of around $200 would fit in reasonably well among the top several components of the average. Some note that the Dow already has one financial insurance company along with several banks, but Berkshire has the benefit of also having numerous major wholly-owned subsidiaries that play leadership roles in their respective industries, such as railroad giant Burlington Northern Santa Fe and aircraft-engine and gas-turbine components and castings specialist Precision Castparts.
Finally, some would prefer to see a pure industrial stock take GE's place. That would open the door to a company like Honeywell International (HON 0.65%), which has a $110 billion market capitalization and has a wide scope of business that includes aerospace, home and building technology, performance materials, and safety and productivity solutions. Yet Honeywell has said that it plans to break itself into three smaller pieces, and that would make the selection a lot less likely.
Watch what the Dow does
With its awareness of history, the Dow won't unceremonious dump General Electric from the average without careful consideration. In the long run, though, such a move is unavoidable, and those overseeing the Dow would do well to consider some of the stocks above as viable replacements.
