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I think this falling knife is about to exit the FTSE 100

There are currently 101 constituents in the FTSE 100 and sitting firmly bottom of the table in terms of market cap is broadcaster ITV (LSE: ITV).

ITV has been a member of the FTSE 100 since March 2011. Having narrowly avoided the drop in June, could it be about to be kicked out of the index at the next reshuffle?

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How does the FTSE 100 rebalance work?

Each quarter there is a rebalancing of the FTSE 100 and FTSE 250 indexes. Market caps are analysed based on the closing price the night before each review.

Any company falling to 111th position or below is automatically removed from the FTSE 100. Conversely, any company rising to 90th position or higher in the FTSE 250 is automatically promoted. In June, we saw Avast, GVC Holdings, Homeserve, and Kingfisher join the FTSE 100. This was at the expense of Carnival, Centrica, Easyjet, and Meggitt.

ITV’s share price has fallen to around 65p, meaning it has lost three-quarters of its value in the last five years. It now has a market cap of £2.6bn. By my calculations, at the time of writing, ITV sits 133rd in order of market cap size.

Unless there’s a significant surge in the share price over the next month, it is probable ITV will be demoted to the FTSE 250 in the September reshuffle. Other than the loss of prestige, the main impact is that FTSE 100 tracker funds would have to sell ITV. While this would be offset by being picked up in FTSE 250 trackers, there is often a short-term drag on the share price.

Should you catch this falling knife?

My Foolish colleague Roland Head sees ITV as a value buy, but I’m not so sure. The share price is certainly dirt cheap right now trading with a potential-to-earnings ratio of around 6. I do see growth in its production arm and I see potential in the subscription Britbox service and ITV Hub.

The problem for me is that ITV makes most of its revenue from traditional TV advertising. I’m not interested that advertising revenues fell off a cliff in April. I see that 42% drop in revenue as temporary while production on many of its blockbuster productions was halted in lockdown and advertisers cut back on spend.

Much more relevant is the fact that profits fell by 17% in 2019. Advertising continues to switch its focus from TV to online streaming services to reflect our changing viewing habits.

ITV could well be oversold right now. As an often-cited takeover target, the sum of its parts may well be worth considerably more than the current market cap of £2.6bn.

But I’m not willing to sit around for that to happen. In my opinion, this is a declining industry. A potential demotion to the FTSE 250 is just one more step in a long downward spiral. If you are looking for advertisers to invest in, I think there are better options available.

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David Barnes has no position in any of the shares mentioned. The Motley Fool UK has recommended Carnival, Homeserve, ITV, and Meggitt. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.