In August 2020, Exxon Mobil Inc., the largest American oil company, was expelled from the Dow Jones Industrial Average, the world’s most famous stock index. It was described at the time as green triumphing over greed. Nearly three years later, the mood has changed. ESG isn’t the coolest financial trend; neither is divesting from oil companies. Regardless of whether the expulsion was right or wrong, the time has come to reverse it.
Sending Exxon to the naughty corner hasn’t hurt it. Since its exclusion, breaking a 92-year-long membership, it has outperformed the index, delivering total returns including reinvested dividends of 212% compared with 25% for the index. Its market value has also surged to $438 billion, from $168 billion the day it was kicked out. Salesforce Inc, the software company that replaced Exxon in the Dow, is currently worth $200 billion.
Exxon isn’t alone. Of the top 15 American companies by market value, eight aren’t part of the index, including Google parent Alphabet Inc., Warren Buffett’s Berkshire Hathaway Inc., and Tesla Inc., the business controlled by the world’s richest man, Elon Musk.
The Dow is an imperfect representation of the American economy. It only includes 30 blue-chip companies across multiple sectors and excludes transportation and utilities. Its weighting methodology, by share price rather than market capitalization, is problematic. Still, the index has stood the test of time and plays a big role in the collective imagination of the investment community.
Who’s in and who’s out is the job of the so-called “Averages Committee,” formed by three executives from S&P Global Inc., the company that owns the index, and two from The Wall Street Journal, because the index was created by the newspaper’s co-founders Charles Dow and Edward Jones. There aren’t any quantitative rules to decide the membership — just broad guidance: “Typically, a stock is added only if the company has an excellent reputation, demonstrates sustained growth, and is of interest to a large number of investors.”
Does Exxon qualify?
Let’s start from the end. Clearly, Exxon is of interest to many investors. Today, it’s the 11th largest company in America by market value, and more than $1.9 billion worth of its stock has changed hands daily over the last year, more than double the median for the index members at about $900 million, according to Bloomberg data. Only two index constituents, Microsoft Corp. and Apple Inc., see higher average daily trading turnover than Exxon.
There’s a nuance to that data. Some investors, particularly those with environmental concerns, have dumped their stakes in recent years. But those objections are fading. BlackRock Inc., an early evangelist of the ESG movement, warned last year that investors pushing companies to meet climate-change targets must acknowledge the “current geo-political context, energy market pressures, and the implications of both for inflation.” Contrast that with the open letter Chief Executive Officer Larry Fink penned in January 2020, months before Exxon was expelled from the Dow, saying climate change had become “a defining factor” in companies’ long-term prospects.
Has Exxon demonstrated sustained growth? You bet. The company has increased its dividend every year for nearly four decades — many of the current members of the index aren’t even close. Is that the best measure of growth? That’s debatable, but it’s certainly a high hurdle to clear; of the 500 companies inside the S&P 500 index, only 65 have managed to increase their annual dividends for at least 25 consecutive years.
Naysayers may argue that Exxon has enjoyed growth in the past, but faces a grim future because oil demand is about to peak. Maybe — but not in 2023, or 2024, or 2025. This summer, in July or August, global oil demand will hit an all-time high, surpassing the record set in mid-2019. Fossil fuels still power the world.
What’s true, however, is that investors no longer value Exxon as richly as they once did. That, perhaps, is its biggest weakness. At five times enterprise value to underlying earnings, Exxon is significantly cheaper than it once was; the average ratio in the past three decades is 8.5 times.
Finally comes the question of “excellent reputation.” Does Exxon have one? Hardly, I would argue. At the very least, it downplayed the risk of global warming for decades; at worst, it led, encouraged, and financed a disinformation campaign that set back the fight against climate change. It has yet to apologize. For years, it treated the news media and its own shareholders with contempt. But some current Dow constituents are similarly tarnished by the fines they’ve paid in recent years to settle cases brought by American regulators and the US Department of Justice.
On balance, Exxon seems to meet the broad guidance to qualify for the index. New leadership is reshaping the company, with a refreshed board displaying more interest in the energy transition and an improved focus on return on invested capital. Against Exxon is, however, another subtle objective of the Dow: to avoid overlapping between companies to broaden the representation of the American economy. Redoing the Dow is a zero-sum game: if Exxon gets back in — and there are precedents of companies returning after several years out — someone has to leave.
The index already has a major oil company, Chevron Corp., and a big petrochemical outfit, Dow Inc. Adding a third oil-and-or-chemical business could unbalance the market measure. But it’s also true that thanks to the shale revolution, the US is today the world’s largest oil and gas producer, pumping almost double what Saudi Arabia does. That’s a strong argument to favor more hydrocarbon companies inside the Dow to better reflect one of the fastest-growing corners of the American economy.
The Dow index would probably benefit from adding more companies from the technology, information, and service sectors. But if that’s an obstacle, then Exxon should replace either oil producer Chevron or chemical maker Dow, both significantly smaller companies. So let Exxon back — and out of the naughty corner.
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