Another stumble in HP's recovery

S&P Dow Jones Indices LLC announced Tuesday that HP would be among three stocks dropped from the Dow Jones index. As the WSJ reported in today’s paper:

Alcoa, a Dow component for 54 years, will be replaced by athletic-gear maker Nike Inc. Payments company Visa Inc. will replace H-P, which joined the index in 1997, and securities firm Goldman Sachs Group Inc. GS will supplant Bank of America, which spent five years in the blue-chip benchmark.

The changes take effect Sept. 20.

That a metals company would be dropped on its 125th birthday is not all that surprising. It is similarly unsurprising that a highflying New York investment bank would replace the Charlotte-based NationsBank (dba BofA), which is still struggling with its decision to buy Merrill Lynch and Countrywide near the peak of the financial crisis. (As a BofA shareholder, my attempt to bottomfish BofA in the fall of 2008 is still looking pretty stupid; if they hadn’t grabbed these two boat anchors, it might have turned out better — but then how could I know that the government would order BofA’s CEO to destroy shareholder value.)

But banks come and banks go. Hewlett-Packard is a Silicon Valley icon, by some measures the founder of the cluster — certainly the first significant Stanford spinoff and the role model for Apple, among others. The end of its 16 year run in the Dow is another sign that it’s just another struggling commodity company in a mature industry. As Bloomberg reported:

HP Exit From Dow Jones Industrial Signals Revival Challenge

Hewlett-Packard Co. (HPQ) is being removed from the Dow Jones Industrial Average, a sign of waning confidence in the company’s turnaround efforts amid an historic slump in the personal-computer industry.

The exit, announced today as part of the biggest reshuffling of the index since April 2004, delivers another blow to Chief Executive Officer Meg Whitman’s quest to revive growth at the storied PC maker.

Blogger Arik Hesseldahl notes the irony of the timing, since HP shares are up 57% this year. He won the standard non-response:

HP remains confident that we are making progress in our turnaround. We have delivered financial performance in line with or better than our expectations throughout this fiscal year, and remain focused on delivering shareholder value. We are already seeing significant improvement in our operations, we are successfully rebuilding our balance sheet, our cost structure is more closely aligned with our revenue and we have reignited innovation at HP.

Unlike leaving the S&P 500, the move has little practical impact on the shares since there are few index products built around the DJ.

Part of the problem for the three companies is that in formulating his first index in 1896, Charles Dow merely added the stock prices together (rather than using a market-cap weighting as in later indices). As the NYT notes

the Dow is calculated as a price-weighted index, so the stocks with the highest share price have the greatest weight. The three stocks that are being removed are priced in the single- or low double-digit range, putting them on the lower end of stocks in the index.

“They’ve dropped the smaller weights out of the index and replaced them with what they deem to be better candidates representing the way the economy is moving,” said Trista Rose, the global head of index strategy at UBS. “I wouldn’t say that it would have a noticeable impact on trading volume.”

For the same reason that HP at $22 is leaving the index, the world’s most valuable company won’t be joining the index. As WSJ blogger Steven Russolillo writes:

Last year John Prestbo, executive director for Dow Jones Indexes, told Barron’s that including Apple in the index would be “a methodological mess” and that Apple “certainly qualifies in every respect except one, price.”

Russolillo notes that the same argument for Apple (at $500) applies to Google (near $900).

Silicon Valley is represented by Cisco and Intel in the Dow, which also includes IBM and Microsoft and America’s two biggest telephone companies, AT&T and Verizon.