Philosophy may seem a far cry from cutting-edge software. But for Benjamin C. Cohen, CEO of Logic Works Inc., the link is as linear as a syllogism. While he earned a PhD in philosophy at Stanford University in 1982, Cohen's studies of artificial intelligence and logic fueled an interest in computers. After brief teaching and research stints, Cohen left academia. "I wasn't cut out to be a professor," he says. "I needed something more exciting."
Logic Works definitely qualifies. Since Cohen started the software company out of his Highland Park (N.J.) basement in 1988, he has tapped into a huge unmet market. High-powered customers such as the Pentagon, General Electric, and even Microsoft use Logic Works software to design sophisticated databases that track everything from customer orders to warehouse inventory flow. Revenues at Logic Works have grown an annual average of 175.7% over three years, to $34.7 million for the latest 12 months. Earnings have jumped an average 153.1%, to $1.7 million.
The blend of high-octane sales and earnings growth, plus a sky-high return on capital, helped Logic Works earn the No.3 spot on BUSINESS WEEK's 1996 list of the 100 fastest-growing small companies. The Princeton (N.J.) company is the biggest player in the roughly $100 million market for such software. But there is no time for resting on laurels. Rivals, including Sybase Inc., a nearly $1 billion company from Emeryville, Calif., are homing in on the lucrative market. Among the innovations expected to keep Logic Works ahead: ModelMart, a $19,995 system that lets programming teams design databases collaboratively. "They will retain the lead," says analyst Charles E. Phillips of Morgan Stanley & Co. "They are more focused, and they've got name recognition."
That competitive drive--and the vision to unearth and exploit untapped opportunities--runs through all the companies on BUSINESS WEEK's 1996 Hot Growth list. It's also what gives them a leg up over much bigger brethren. Even as a slowing economy started to dull growth in Corporate America, these red-hot companies continued to sizzle. For the last three years, the 100 companies saw sales grow an average of 60.8%, vs. 7.2% for the Standard & Poor's Industrial index. Earnings grew 139.4%, vs. the S&P's 26.9%, while return on invested capital hit 27%, vs. 11.2%.
EFFICIENCY EXPERTS. Logic Works isn't the only Hot Growth company riding the technology wave. Software and computer-service providers made up 23 of the listed companies, while semiconductors, components, and telecommunications added 10 more. "There is a strong effort to keep costs down, and to do that you have to invest in new equipment," says David A. Wyss, research director at DRI/McGraw-Hill. That includes this year's No.1, Remedy Corp., which makes computer help-desk software. Symetrics Industries (No.12) makes components for telecommunications systems. ESS Technology Inc. (No.26) builds audio chips that let multimedia computers truly sing.
Many of these tiny dynamos are profiting from outsourcing, downsizing, and Corporate America's push for efficiency. Through a dozen rural call centers, APAC TeleServices (No.4) staffs customer-service lines for such clients as J.C. Penney Co. Eltron International Inc. (No.2) makes bar-code printers and software allowing customers such as United Parcel Service of America Inc. to track shipments and inventory.
Many others have succeeded by trolling decidedly low-tech waters. Companies such as small town video-rental chain Movie Gallery Inc. (No.13) and nursing-home operator Retirement Care Associates Inc. (No.7) have prospered by developing lucrative niches--then gobbling up smaller rivals.
For small companies in search of capital, 1995 proved to be a stellar year. Although the total raised through initial public offerings, $31.1 billion, dropped slightly from 1994's $34 billion, the market heated up in the final quarter. The red-hot pace continues: For the first four months of 1996 alone, IPOs raised $14.7 billion. The story was even better in the venture-capital market, where $4.4 billion was raised, an all-time high.
Still, the market wasn't exactly enamored of small companies last year. Even many Hot Growth companies that delivered sparkling earnings and sales gains lagged big-caps. Shares of the stocks on this year's list traded at an average of 81% of their 52-week highs, while the average S&P industrial stock is trading at 89.8% of its 52-week high. It's no secret why: Wall Street went for big consumer and manufacturing companies last year as many, buoyed by cost-cutting, turned in surprisingly strong earnings. A weak dollar, which increased foreign sales at many multinationals, also helped. "Small companies took a backseat to the overall market last year," says John W. Ballen, portfolio manager of MFS Emerging Growth Fund. "But this year, small companies are back in the leadership position."
That's because many investors figure that fast-moving entrepreneurs will do a better job than their larger rivals at keeping up the momentum as the overall economy winds down. Wyss also adds that small companies tend to be in sectors that depend less on the business cycle. So far this year, the Russell 2000 small-cap index is up 12.8%, compared to 7.2% for the S&P 500. The only cloud on the horizon: "If interest rates continue to charge upward, that is the greatest threat to the current bull market in growth stocks," warns James P. Goff, co-manager of the Janus Venture fund.
If potential rewards are high, so are the risks. Small companies often wither as quickly as they blossom. Consider last year's No.1, toymaker Happiness Express. A string of hit gadgets based on the popular Mighty Morphin Power Rangers TV show had sent its fortunes soaring. But Happiness Express jumped the track in 1995. First, sales and earnings tumbled as the Power Rangers fad died out. And in early May, the company announced that possible accounting irregularities would lead to greater than anticipated losses. The shares have tumbled from 15 to below 3.
Think of it as a cautionary tale for fast-growing tiny companies--and those who invest in them. The trick for this year's highfliers is to navigate the downdrafts and continue to soar ahead of the flock.