After General Electric (NYSE: GE) was kicked out of the Dow Jones Industrial Average (DJIA) on Tuesday, shares plunged nearly 2%. This after the shares have slumped almost 27% year-to-date, and 54% in the last 12 months.
But investors shouldn’t give up on the conglomerate just yet.
Once the most valuable company in the world, GE is in the middle of a multi-year turnaround that will see it ditching superfluous businesses and re-focus on its industrial roots – a process that has spooked impatient investors.
While being kicked out of the DJIA may seem like another nail in the coffin for this once-dominant industrial and manufacturing giant, it may prove to be just the kick the stock needs.
Consider IBM (NYSE: IBM).
IBM was ejected from the Dow in 1939. It wasn’t until 1979—after 40 years of the stock soundly beating the overall market—that it was added back into the index. And according to Norman Fosback, head of the Institute for Economic Research, “the DJIA would today be worth more than twice its currently quoted level” if IBM hadn’t been kept out of the index for those forty years – putting the Dow around 50,000 today…
IBM isn’t the only case of success after being booted from the index. Stocks removed from the benchmark usually outperform the stocks that replace them on the Dow.
Of two dozen stocks that have been deleted or added to the Dow since 2000, the average removed stock beats the average added stock by a substantial amount over the following year, and is still ahead after 5 years.
Kicking GE out of the Dow likely won’t be of much consequence for the benchmark. GE however, may have the last laugh.
“We sense GE’s removal from the Dow Jones Industrial Average, while [an] historic change for one of its original members, reflects the evolution in the current drivers of the U.S. economy,” analysts at William Blair wrote in a note to clients. “GE’s stature as a predictive component of the DJIA has steadily declined over the past decade, and thus the change could be viewed as long overdue.”
William Blair’s analysts then noted that GE’s shares are at “an inflection point for investor sentiment,” and believes shares are “likely to offer material upside potential over the near and intermediate time horizon.” Indeed, according to FactSet data, 18 of the analysts who cover GE have it rated as a buy or overweight.
Boris Schlossberg, managing director of FX strategy at BK Asset Management, told CNBC that he “would be a buyer, but with a caveat… I would wait for at least two to three weeks for all the closet indexers to get rid of the stock because I still think there’s going to be some selling pressure on the stock, residual selling pressure, for the next couple of weeks.”
But don’t expect the recovery to be a smooth shot upward. “You could really anticipate the stock could maybe wash out below $10 before it really turns around,” Schlossberg said. “If you’re going to assume a position you have to really be willing to assume some pain in the near term to get some long-term gain over the next five years.”