Should The Dow Ditch General Motors?

GM's troubles are skewing the index and battering investors who bet on it

When Charles H. Dow created the Dow Jones industrial average in 1896, he likened it to a stick jammed into the sand at the beach -- a steady reference point for observers to measure the ebb and flow of the U.S. stock market.

Judging from the index' recent performance, the wooden stick might need some repositioning. General Motors Corp. (GM ), one of only 30 "blue-chip" stocks that make up the Dow, plunged in 2005 to a 23-year low -- costing the index nearly 200 points. As a result, through Dec. 23, the Dow lagged behind the other widely followed market gauge, the broader Standard & Poor's 500-stock index, significantly: The S&P 500 was up 6.5%, while the Dow was up less than 1%. (Standard & Poor's, like BusinessWeek, is a unit of The McGraw-Hill Companies.)

The poor performance wouldn't matter if the Dow were merely a statistic cited in newspapers. But beginning in 1998, investors have been able to "buy" the index via the Diamonds Trust, an exchange-traded fund (ETF) that tracks it. Almost $7.5 billion sits in the Diamonds Trust. Since spring, when GM began to slump, investors who bought the ETF based on the S&P 500 have handily beaten those who bought the Dow.

Almost no one would describe General Motors as a blue-chip stock these days. So why, ask some Wall Street veterans, is GM still in the Dow? "They long ago ceased being a barometer of the U.S. economy," says Jeffrey N. Kleintop, chief investment strategist at PNC Advisors in Philadelphia. Only General Electric Co. (GE ) has a longer tenure in the index than GM, which joined in 1915. Long gone are ghosts of industries past like U.S. Steel and National Lead.

GM is still a huge company, with annual sales of almost $200 billion. But the company's share of the global auto market has fallen from a peak of 51% in 1962 to 26% today, and Toyota Motor Corp. (TM ) could surpass it in 2006 to become No. 1 worldwide. Worse, GM has massive pension obligations, and it gushed $3.8 billion of red ink in the first three quarters of 2005. Credit-rating agencies are bandying about the "B" word: bankruptcy. "This isn't a farfetched possibility if the kind of deterioration in results we've seen over the past few quarters should continue," said S&P analyst Scott Sprinzen during a Dec. 12 conference call with reporters and analysts. S&P on that day cut GM's corporate credit rating to B, five steps below investment grade. (GM declined to comment on its status as a member of the Dow.)

Some of GM's major shareholders are dumping the stock. Capital Research & Management Co., which runs American Funds, sold 15.5 million shares in the third quarter. More recently, Kirk Kerkorian's Tracinda Corp., which took a big stake earlier in the year, disclosed on Dec. 20 that it had sold 12 million shares.

General Motors has been a drag on many stock market indexes this year, but its effect on the Dow has been especially pronounced. The Wilshire 5000 and the S&P 500 weigh stocks by their market value. But the Dow has always weighed each company according to its share price. That makes GM, at just below $19 a share, almost as important as Microsoft Corp. (MSFT ), which trades around $26 a share but has a market value 25 times greater. If GM shares were to fall to zero, S&P 500 investors would lose less than one-tenth of 1% . Dow investors would lose more than 15 times that. The Dow "is so strange as an index that it's just scary as an investment," says Tulane University finance professor Peter Ricchiuti.

Few expect Dow Jones & Co. (DJ ) to make a change unless GM takes a turn for the worse. The index is chosen by the editors of The Wall Street Journal -- who, over the years, have been cautious about altering the index. Famously, Dow Jones added Microsoft, Intel (INTC ), and SBC Communications (T ) in November, 1999, at the height of the technology bubble. John Prestbo, executive director of Dow Jones Indexes, says he's watching the situation now. "I look in the paper everyday for news about GM," he says. Lately, there has been plenty to read.

By Aaron Pressman

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