It's no small feat to spot a great business opportunity in today's fast-changing economy. Building a sustainable enterprise from that insight is even tougher. It requires speed, flexibility, innovation, and at least a little luck to thrive in the face of relentless competition. This year's annual Hot Growth list of America's fastest-growing small companies reveals an impressive lineup that has mastered that high-stakes game. Consider Las Vegas-based Shuffle Master Inc. (SHFL ). Founded in 1983 by John Breeding, an entrepreneur who figured out how to make a reliable card-shuffling machine that allowed casinos to quickly and securely deal more hands, the company has cashed in big on the explosive growth of new casinos and the resurgent popularity of poker.
That wasn't enough for Shuffle Master. Breeding left the company in 1997, but current Chairman and CEO Mark L. Yoseloff is extending his company's winning streak by plowing profits into finding new products. A former college professor with a doctorate in math from Princeton University, Yoseloff invests more than 12% of the company's revenues in research and development, far more than most peers.
Spending big has helped the company stay on top in its niche with an array of sophisticated new machines -- the latest of which can quickly shuffle through a deck of cards and determine whether the deck is full. That saves casinos money by allowing them to open fewer new decks. The R&D has also led to a new line of business for the company: proprietary card games such as Let It Ride and Crazy 4 Poker, which the company licenses to casinos. Royalties from such games now make up half of revenues. ``We're doing a lot of things besides being that shuffler company,'' says Yoseloff.
As a strategy, it's better than an ace in the hole. Over the past three years, as the broader economy moved through recession and into a slow recovery, the company has consistently posted top-notch numbers. Sales have grown an average 19.8% a year, to $68.8 million, while net income has climbed 25.2%, to $18 million, good enough to rank them No. 19 on our annual Hot Growth list.
ON THE PULSE Shuffle Master's strength in a tough economy is no fluke. Over the past few years, smaller companies generally have played an outsized role in bolstering a shaky U.S. marketplace. Strengthened by low interest rates on their borrowings and a focus on consumers who kept on spending, smaller players were vital to the overall economy in the recent down years. ``Small businesses have been a source of stability to a very troubled economy, and more recently a key source of growth,'' says Mark Zandi, chief economist of consulting firm Economy.com Inc. Just as important, the group has been an incubator of new ideas, some of which will undoubtedly change our world. Alumni of our Hot Growth list include network titan Cisco Systems (CSCO ), video game leader Electronic Arts (ERTS ), and such familiar names as Black Entertainment Television (VIA ), Papa John's International (PZZA ), and eBay (EBAY ).
The ability to find -- and then exploit -- a sweet spot in the economy is still the common denominator of our list. Our top company, PetMed Express Inc. (PETS ), forged a whole new industry by selling pet medications via e-mail, phone, or fax. Though now under pressure from veterinarians unhappy with losing this profitable business, the company has already become America's largest pet pharmacy. Others have just as smartly played the challenging job market. No. 3 University of Phoenix Online (UOPX ) is one of several education companies helping people make themselves more marketable. Universal Technical Institute (UTI ), No. 2, trains automotive technicians in servicing everything from trucks to boats.
Baby boomer spending combined with low interest rates and a housing boom have been the forces behind No. 39 SCP Pool Corp. (POOL ). The world's largest wholesale distributor of pool supplies, SCP's sales rose by 19.4% a year, on average, over the past three years, to $1.19 billion in 2003. CEO Manuel J. Perez de la Mesa is riding a wave of new-pool building that could sustain the company for years to come. Some 80% of SCP's sales are supplies necessary for the upkeep of the 7 million swimming pools already installed.
Health care is such an engine of growth that 19 of our companies are drawn from its ranks, up from 9 in 2001, a reflection of a general explosion in medical spending. To help insurance companies and big employers grappling with soaring health-care costs, No. 32 American Healthways Inc. (AMHC ), for example, employs a team of nurses, dieticians, and therapists in eight call centers around the country. Under contracts with insurance companies, this medical swat team contacts members with chronic diseases such as diabetes and asthma to educate and coach them on how to deal with their condition, including ensuring they get the right tests and medications.
To zero in on such innovators, BusinessWeek looks at a broad universe consisting of publicly traded companies with revenues ranging from as little as $50 million a year to as much as $1.5 billion. Then we rank them by sales and earnings growth and return on capital over a three-year period to identify those companies with a solid track record. Any company on the list must have a market cap of at least $25 million and a share price of at least $5. And we cut any company that has had recent earnings slides or whose stock has underperformed the Standard & Poor's Industrial Composite Index. The top 100 contenders make our list.
By the numbers, they're an impressive bunch. Average annual sales growth over the past three years for the group hit 26.9%, while average earnings growth was an even stronger 79.3%. By comparison, the S&P industrials posted sales and earnings growth of 4.5% and 0.5%, respectively, over the same period. Even more heartening, the average return on capital for our Hot Growth 100, a good measure of how well management is deploying its assets, was 17%, vs. 4.4% for the S&P industrials.
IN THE RIGHT PLACE No doubt some of these companies benefit from good old-fashioned luck. Considering how the war on terror and the war in Iraq have boosted defense spending, it's no surprise that a number of defense and security-related companies rank high on the list. And in today's lean military, there's plenty of demand for help. ``There is not a lot of increase in internal manpower in the [armed] services,'' says David S. Gutridge, CEO of No. 11 MTC Technologies Inc. (MTCT ). ``That has helped create a need for additional contractor services.'' MTC provides engineering support and other services to the U.S. Defense Dept. and intelligence agencies and has generated an average return on invested capital over the past three years of 32.5%, among the highest on our list. No. 33 Engineered Support Systems is also using cash generated by war-time demand for its heavy-duty air conditioners to build out a portfolio of military offerings and push annual sales increases to more than 15%.
While some on the list are helping the government wage war, others are simply aiding bigger companies in their everyday battle for market dominance. No. 13 Cognizant Technology Solutions Corp. (CTSH ) does IT outsourcing for big companies like MetLife and J.P. Morgan Chase using teams of software developers in India. And Charles River Laboratories International Inc. (CRL ), No. 57 on our list, provides biomedical research products and services, including genetically altered animals for drug safety testing, to Big Pharma players. ``They are utilizing our staff and facilities to do things faster,'' says Charles River Chairman and CEO James C. Foster. ``Everything in this business is about speed to market.''
BARGAIN HUNTING In that drive to market, some opportunities are always left behind. Those tasty scraps are meat and potatoes for some Hot Growth companies. No. 18 Bradley Pharmaceuticals Inc. (BDY ) acquires, enhances, and markets drugs developed by larger drug companies but deemed too tiny to be worth promoting. A moisturizing cream the company bought from Syntex Corp. in 1994 has spawned a whole line of skin products, which helped generate $84.8 million in sales over the past year. Similarly, Encore Acquisition Co. (EAC ), the No. 73 company run by the father-and-son team of I. Jon Brumley and Jonny Brumley, acquires and develops the relatively small oil fields that their larger competitors aren't interested in expanding. In 1999 the company bought a field in southeastern Montana from one of the major oil producers, and after reengineering it has boosted production from 8,600 barrels a day to 12,600. That has helped send earnings up an average of 91.8% annually over the past three years.
Of course, rising energy prices have also given Encore a boost, as they have to No. 77, Matrix Service Co. (MTRX ), which provides maintenance, repair, and construction services to refineries, pipeline and marketing terminals, and power plants. With oil at $40 a barrel, it's hard to see that trend ebbing.
Lucky, however, cuts both ways. Regular readers of this list will note that information technology, long a staple, has been hurt by the anemic economy of recent years, which forced Corporate America to hold back on capital spending. The number of hardware, software, and semiconductor companies on our list has withered -- from 41 in 2001 to 11 this year.
Of course, a reinvigorated economy will help technology and nontech players alike in the year ahead. But it won't dampen the pressure to outsmart rivals with innovative new products and services. This year's crop of dynamos are eager for that challenge.
By Amy Barrett in Philadelphia with Christopher Palmeri in Los Angeles and Stephanie Anderson Forest in Covington, La.