Tuesday, June 2, 2009

GM and the Dow

The bankruptcy of General Motors will certainly have plenty of ramifications for our economy, but there's one relatively trivial one that investors might want to take note of. Bankruptcy results in an automatic removal of a company from the Dow Jones Industrial Average. Since there are only 30 companies in the Dow, this might seem to be a fairly significant change.

And it's actually a switch of two companies. Dow Jones is taking the GM bankruptcy as an opportunity to remove the struggling Citigroup from the index as well. Cisco Systems will replace GM, and in an ironic move, Citigroup will be replaced by Travelers, which it had spun off seven years ago.

So can we expect a big jump in the Dow on June 8th, when the change will take effect? After all, GM is now priced at under a dollar, while Cisco has been trading around 20. But the Dow adjusts for this. The index is not simply the average of all 30 stocks included; the divisor is changed to reflect changes and keep an apples-to-apples comparison, even when the included companies get swapped around. So when this change takes effect next Monday, don't expect to notice any big disruptions in the Dow.

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