The Final Slap in the Face for Citi

While Citi clearly has had problems during the past two years, it is still a blue chip company. The company is part of the Dow Jones Industrial Average (DJIA). So they should be safe. Not so fast my friend…(for you sports fans, that’s a Lee Corso line – and if you hadn’t heard, Lee Corso had a small stroke this past week – personally, I find him to be hilarious and I’m hoping he gets better soon).

This week, Dow Jones announced changes in the DJIA (and S&P announced a change in the S&P 500). Dow Jones removed GM and Citi from the index and replaced them with Cisco and Travelers. This is the most recent slap in the face for Citi.

It was relatively obvious that Citi and GM would be removed (I spoke about it in our evening MBA program earlier this semester). The reason that this was obvious is that the Dow Jones Industrial Average is “price weighted” – which means that the importance (weight) of each stock is based on its price. In other words, a 10% move in a $30 stock would have three times as a large an impact on the index as a 10% move for a $10 stock. The thing to realize about this is that we have no idea whether the $30 stock or the $10 stock is a larger company. The $30 stock may only have 1 million shares outstanding (making its market cap $30 million) and the $10 stock may have 1 billion shares outstanding (making its market cap $10 billion). While the DJIA is price-weighted, most stock market indexes are market cap weighted. (Others are equal weighted or fundamental weighted.)

The fact that the DJIA is price-weighted and the two stocks are priced so low (GM’s stock is trading for less than $1 and Citi is trading for less than $4) resulted in their removal (GM’s bankruptcy filing also indicated it might not be a “blue chip” stock…). These low prices meant that changes in these companies’ stock prices had little discernable effect on the index. There’s no point in having a stock in an index if a move in the stock’s price is meaningless to the index.

Citigroup still has a decent-size market cap ($20 billion), but they have so many shares outstanding that the per share price is low (less than $4). The ultimate insult for Citi is that they were replaced with Travelers. Travelers had been part of Citi until it was spun off in 2002. St. Paul Cos. acquired Travelers in 2004 and the combined company uses the name Travelers. Aside from the pure insult value of being replaced by your child (without the pride of your child’s accomplishment), this also makes people take notice of the fact that the market cap of Travelers ($24 billion) is larger than the market cap of Citi ($20 billion). (Realize that this comparison is not fair since Travelers merged with St. Paul Cos., but the sting still exists.) The best analogy is probably how a father feels when he finds out that his child is taller than him and it’s not because his child has grown; rather, dad has shrunk.

While Citi executives cry into their beer (cheap, domestic beer produced by a non-American company…), GM executives can sit on the stool right next to them. This fine auto company was replaced in the S&P 500 by the fine education company…DeVry.