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Walgreens-GE Faceoff: How Impactful is it for Dow Investors?

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Walgreens Boots Alliance (WBA - Free Report) has achieved a historic feat yesterday on emerging as the youngest participant on the Dow Jones Industrial Average (DJI) or DJIA. This is a momentous exploit not just because this goliath stock has entered the world’s most coveted index but more so for dramatically replacing Dow’s oldest member, General Electric Company (GE - Free Report) . With this success, Walgreens stalled GE’s uninterrupted run on the exchange for 110 long years.

The change will be effective Jun 26 market opening.

Let’s delve deeper into the significance of the decision for Dow investors.

GE Booted Off: How Far is This Logical?

The S&P Dow Jones indices report says that “General Electric was an original member of the DJIA in 1896 and a member continuously since 1907”. However, per the index, this decision was prompted by the GE stock’s persistent trading at a low price of late, which affected the entire index’s price performance in turn.

 

Going by the report, “the DJIA is a price-weighted index and the range of prices among its 30 constitutes matter. The low price of GE shares means the company has a weight in the index of less than one-half of one percentage point.”

Overall, GE’s market capitalization rose to $594 billion in 2000 and has shrunk unbelievably over the years to $111.87 billion at present.

Over the past year, shares of GE have nose-dived by more than 50%, a significant plunge justifying the above logic. If we compare the stock with its broader industry, the stock has plummeted 52.1% compared with the industry’s 16.7% decline.

For the same time frame, DJIA has rallied 16.9% and another sought-after index, S&P 500, remained slightly below at 13.7% growth. Both indices however, remained far above the General Electric’s tally.

 

Walgreens’ DJIA Foray: Does it Make Sense?

While talking about the decision to incorporate Walgreens on the DJIA index, the S&P Dow Jones indices report informed that Walgreens will contribute more meaningfully to the index as its share price is higher than GE’s. The stock will also help the index represent the U.S. market and economy in a better way.

The investment world has already been dissected into two with respect to this impactful decision. Per David Blitzer, chairman of the S&P’s index committee, industrial companies like GE no longer hold prominence in the American economy, whereas healthcare, banks, tech and consumer companies race as front runners now.

From Walgreens’ point of view, this world’s first pharmacy-led, health and wellbeing enterprise has never has been shoved away from the limelight, courtesy of its consistent flow of strategic developments. The company has been formed through the combination of legacy Walgreens and Alliance Boots. The merger brought together a couple of companies with compelling portfolios and iconic brands, complementary geographies, shared values and trusted health care services via pharmaceutical wholesaling and community pharmacy care.

Recently, in a bid to ensure availability of specialty brand drugs, Walgreens has tied up with Express Scripts (ESRX - Free Report) and announced plans to expand their existing group purchasing efforts. Also, Walgreens’ Rite Aid (RAD - Free Report) contract will extend its growth strategy and offer operational as well as financial benefits.

Following the news, shares of Walgreens gained 5.24% to $68 at yesterday’s close.

The Opposite View

On the flip side, some are questioning the practicality of substitution as CVS Health (CVS - Free Report) is a bigger contender of Walgreens in the similar field in terms of market cap, volume and prescription revenues.

According to the analysts, Walgreens incurred immense debt to maintain its expansion through acquisition strategy.The company’s long-term debt shot up to $12.5 billion as of February 2018 from $3.7 billion in August 2013 (per a Wall Street Journal report).

Moreover, while CVS Health is currently in the process to complete its $69-billion Aetna (AET - Free Report) deal, its decision to buy the health insurerhas been taken quite positively by the investment world. Economists are looking forward to this development as they think this vertical integration might finally put brakes on America’s mounting health-care costs. In spite of this huge prospect, CVS Health not present in the list of 30 Dow members is putting the investors in sort of dilemma.

 

Walgreens’ stock performance too is currently not looking much convincing. Over the past year, shares of Walgreens have lost 17.9%, outperforming the DJIA and S&P 500 index. The broader industry has witnessed a 10.7% decline. Per a Bloomberg report, “On paper, Walgreens Boots Alliance Inc. is an underwhelming choice for inclusion in the world’s most famous stock index.”

How Significant the ‘Delete’ & ‘Replacement’ Will Be?

According to many investment experts, the General Electric-Walgreens case is more of a publicity stance for Dow, gradually losing its sheen since the economic recession of the 1990s. Going by a Reuters’ article, “GE is currently the sixth smallest member of the Dow by market value, and it sports the index’s lowest stock price, making it the least influential component of the price-weighted average.”

A Lipper data also concluded that while just $20 billion is invested in exchange traded funds attached to the Dow, ETFs tracking the S&P 500 index, have assets of around $380 billion. Undoubtedly, next week, GE’s exit and Walgreens’ entry may not have any relevant effect on the performance of the index.

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