Hot growth stocks can take investors on a crazy ride. In 2005 specialty drinks maker Hansen Natural (HANS ) was riding high on sales of Monster Energy, a caffeine-laced beverage that ranked second only to Red Bull in the energy-drink category. Two years later its stock is down 24% from its July, 2006, peak, and the company, at the request of the Securities & Exchange Commission, has launched an inquiry into past stock-options grants. On May 14, Hansen said it had understated stock option and related expenses by $1.3 million between January, 2001, and June, 2006, because of unintentional accounting errors. Nevertheless, the stock returned 439% over the past two years, making Hansen the top performer of the Hot Growth Class of 2005.
Each spring, BusinessWeek takes a look back at our Hot Growth list from two years earlier. That allows enough time to account for any short-term anomalies in a given business and to make fairer comparisons with indexes. The majority of the Class of '05 are finishing up a strong two-year stretch. Of the 100 companies, 62 posted positive returns, and 26 companies saw share prices drop. A surging mergers-and-acquisitions market led 12 companies to be taken over. Over the two-year period, the Russell 2000 small-cap benchmark index climbed 44.1%.
The Hot Growth Class of '05 lagged that benchmark index a bit: On a market-cap-weighted basis, the group is up 33.5%, a hair above the 33% for the Standard & Poor's 500-stock index. And large caps may in fact overtake their smaller brethren in 2007—they've outperformed the Russell 2000 index on a year-to-date basis, notes Steven DeSanctis, director of small-cap research at Prudential Equity Group (PRU ).
The Hot Growth Class of '05 is an eclectic bunch. But some general industry trends show up in the results. The list of worst performers is populated by companies that catered to flush consumers, including trendy furniture retailer Design Within Reach (DWRI ), powerboat manufacturer Marine Products (MPX ), and eco-friendly building materials company Trex (TWP ). Back in 2005 such companies were benefiting from house-rich consumers' optimism, says Robert Stimpson, who manages the small-cap fund at Akron-based Oak Associates. Today, Stimpson says, their sinking fortunes reflect the housing slowdown and consumer concerns about energy prices.
Companies remaining in the winner's circle offered products and services tied to a growing need. They include Meridian Bioscience (VIVO ), a maker of rapid diagnostic medical tests, and Bio-Reference Laboratories (BRLI ), which does clinical testing. "Pathogens are getting more robust and moving around the world very quickly these days," driving demand for Meridian's tests, says President John Kraeutler.
Other companies that sustained their hot growth include Ceradyne (CRDN ) and Armor Holdings (AH ), both of which make armor and other protective products, primarily for the defense industry. Armor's growth was so impressive that British defense contractor BAE Systems announced on May 7 that it would be acquiring the company. Then there's Cognizant Technology Solutions (CTSH ), which has been on the list for six years running and seven times since the list launched in 1985. The information-tech outsourcer faces stiff competition from big rivals such as Wipro (SIT ) and Infosys Technologies (INFY ).But Stimpson, who has long held the stock in his funds, says it offers "better, faster, cheaper" service than other IT outfits. And being better and faster than the next guy is what Hot Growth is all about.
By Elizabeth Woyke