By BENJAMIN MIRASKI, MEDILL NEWS SERVICE
It’s not a new idea. It might not even be a very nice idea. However, it’s probably the right thing to do.
It is time to remove General Motors Corp.[[GM]] from the Dow Jones Industrial Average.
The company announced Tuesday that it will reduce salaried employees, step up plant closings, cut back benefits to retirees, and most importantly, drop its dividend.
This is no summer shutdown. This is a full-blown spiral of destruction.
You can’t feel good about the prospects for the company when, despite glowing newspaper headlines, such as the Chicago Tribune’s July 16 article, “GM paves road to sales rebound by 2010,” the company continues to burn through large amounts of cash. In the first quarter alone, GM’s net cash flow fell by more than $3 billion.
Worse, the company itself can’t predict when a turnaround might come. “Your guess is as good as mine,” GM Vice Chairman Robert Lutz told the Chicago Tribune.
In the past, when industries stopped being an integral part of the U.S. economy, the stocks of those industries have stopped being represented in the Dow.
There is no more U.S. Leather. There is no more U.S. Rubber. Even Eastman Kodak Co.[[EK]], a member of the index starting in 1930, was eventually replaced as it lost importance thanks to the emergence of digital cameras in 2004.
So shouldn’t the U.S. auto industry, long since surpassed by the innovation and forethought of Japan, also be replaced?
Even with annual sales of $181 billion, General Motors is no longer the largest auto maker in the world. That title fell to Toyota Motor Corp when its sales topped $229 billion in its last fiscal year.
Even so, Morningstar analyst David Whiston is skeptical about a change occurring in GM’s elite membership status.
“There is probably a lot of nasty politics that would go with that,” Whiston said. “They don’t want to take it out too early…There is always a chance for a turnaround with someone like GM.”
Yes, removing GM will have its consequences, some of them harsh.
Index funds which track the Dow will all sell the stock on the day it leaves the index, replacing it with the new company. This will result in greater price erosion in a stock that is already down.
For comparison, when Honeywell International Inc.[[HON]] was removed from the Dow in mid-February, its shares lost 2.5 percent of their value in one day on 3.5 times the average volume of the stock.
It isn’t just be the big investors that leave a stock once it’s dumped from the Dow.
One common strategy in the investment world is to invest in what are called the “Dogs of the Dow.” This strategy consists of investing in the Dow stocks with the top ten dividend yields. This strategy has outperformed the S&P 500 for the past year, three years, five years, and fifteen years, according to statistics compiled by Dogs of the Dow.
A more focused strategy involves investing in the small dogs, which are the five Dogs of the Dow with the lowest prices as of the investment date. With that investment, you would have outperformed the Dogs of the Dow and beaten the S&P 500 in the 10-year period where the regular dogs failed.
GM was both a dog and a small dog; however, its dividend is no more.
That means that individual investors that follow these strategies are bound to sell this stock within the next year, another pressure from the short side.
To point, GM stock is likely to take a fall, even below the currently depressed price near $11, already down 75 percent from its 52-week high of $43.20.
Whiston did postulate that the end result could be more than just price erosion.
“There might be a psychological impact,” he said.
Where should the Dow turn for a replacement? CNN Money might have had the best suggestion.
Not Apple[[AAPL]], especially not when people can’t seem to find a super-compelling reason to buy the new iPhone.
Not Pepsi[[PEP]], still second fiddle to Coca-Cola[[KO]].
No, the answer they hit on the head was Kraft[[KFT]], the second largest food company in the world, and the largest in the U.S.
It has profits. It has an ambitious growth plan which doesn’t rely on massive cuts in order to achieve it. Kraft has an iconic brand, one that is not tarnished by years of management trouble, or a gas-guzzling image. And if it is good enough for Warren Buffett, why isn’t it good enough for the Dow?
So, hit the road General Motors, and don’t you come back no more.