The Business Week 50
In a period marred by slowing computer sales growth, allegations of antitrust, Capitol Hill hostility, and even a pie in the face, there is one thing William H. Gates III hasn't had to worry about: corporate performance. Whether you think Microsoft Corp. anticompetitive or simply ultracompetitive, under Gates's leadership it has racked up a record of annual profit and revenue increases that is the envy of Corporate America. "We've been cruising for 22 years," says Gates, Microsoft's chairman.
It sure looks like full speed ahead to the rest of us. With earnings galloping ahead 57% last year, the Redmond (Wash.) software giant turned in an eye-popping 76.3% gain for shareholders. That was enough for Microsoft to knock chipmaker Intel Corp. out of the No.1 spot in BUSINESS WEEK's second annual performance ranking of the 500 companies in the Standard & Poor's index. And getting there was no easy ride: To earn the highest honors, Microsoft blew past staunch competition from such top 10 sizzlers as Dell Computer, Cisco Systems, credit-card dynamo MBNA, and Morgan Stanley Dean Witter & Co.
Ask Gates what's behind the success that has kept his company several steps ahead of such a crowd, and he credits being in the right business at the right time. "It's the Information Age, and we're giving people great tools for getting at and handling information," he says. There's certainly more to it than that. Thanks to the legendary aggressiveness Gates fosters, 90% of the 80 million PCs shipped last year were loaded with one version or another of Microsoft's Windows operating systems. But what's really impressive about Microsoft is its obsession with efficiency and gradually improving products.
From every dollar in sales, Microsoft pulls out 29.7 cents in profits--a margin that grew by 13% over the year before. That's almost four times the average for its industry, and better than all but four other companies in all the 500. Moreover, between fiscal 1995 and 1997, the company's share of revenues going into research and development climbed from 14% to 17%--without denting profits. "How do we do it? We watch costs like a hawk," says Microsoft President and Chief Operating Officer Robert J. Herbold.
Given the phenomenal growth that the PC industry has seen in recent years, it's no surprise that Microsoft would top BUSINESS WEEK's ranking of corporate performance. It moved up a notch when last year's winner, Intel, slipped down to No.4. High-tech leaders Dell, Cisco, and Compaq Computer round out the first five spots. But if it helped to be in a fast-growing high-tech field, it was hardly necessary: The top performers cut a wide swath across Corporate America. This year's BUSINESS WEEK 50--our exclusive ranking of best overall performers among the S&P 500 companies--includes everyone from drug giant Pfizer Inc. and long-haul truckmaker PACCAR Inc. to oil services giant Schlumberger Ltd. and clothing retailer Gap Inc.
DYNAMISM. That's because we developed our Performance Rankings to reflect more than just size by sales or market capitalization. Instead, we created a ranking in which the best in each industry--and the best overall--truly shine through. Unlike more traditional lists, in which big is defined as best, we place a premium on the dynamism and growth that successful companies must cultivate to survive.
After all, in today's hugely competitive global economy, what really matters? For small companies and their larger brethren alike, it's the ability to grow--to keep pushing up sales, piling up earnings, and, most important, to continue rewarding shareholders with ever-higher returns. "Great companies try to grow, to be innovators forever," says Charles E. Lucier, a consultant with Booz, Allen & Hamilton Inc. "It's hard to sustain."
For proof, look no further than this year's Performance Rankings and the BW 50. Like the American economy they reflect, our rankings provide a dynamic canvas against which brutal competitive realities stand out; it's a fast-moving portrait in which rising stars push aside companies that have stalled out. Although they won't look like many other best-of lists you've seen, the Performance Rankings are likely to provide far more insight into which companies really soar above the crowd.
Certainly, that was the case with last year's BW 50. As a group, they continued to outperform: Over the 12 months ended March 13, shares of the BW 50 companies rose a heady 47.7%, handily beating both the 34.7% turned in by the S&P 500, and the 24% gains tallied by the Dow Jones Industrial Average. With a stunning 260% price gain, Dell was the star, followed by EMC with 115%, and Schering-Plough with 104%. But they weren't the only overachievers: In all, 31 of our top 50 beat the S&P-500 index.
SAVVY MARKETING. So what made the best stand out? Though no two companies made it onto the BW 50 for exactly the same reasons, distinct trends emerge that go well beyond one industry or a star manager. The enormous wave of mergers and acquisitions now sweeping Corporate America clearly left its mark. From Dean Witter's marriage to Morgan Stanley, to discount clothing giant TJX Companies Inc.'s purchase of former rival Marshalls Inc., more than a dozen of this year's stars turned to acquisitions to fuel their rapid-fire growth.
Elsewhere, there are trends to note as well. General Electric Co. and Microsoft demonstrate that the drive for corporate efficiency is no thing of the past. The steady success of the drugmakers exemplify the unbeatable combination of innovative product and savvy marketing. And remember the adage the customer is always right? Manufacturer Applied Materials Inc. and little-known EMC Corp., a maker of computer storage systems, prove that old saw, too, is alive and well.
How did BUSINESS WEEK find the stars that best exploit these trends? To sort out the best performers among Corporate America, we employed a range of key measurements that investors and managers alike use to judge operating and financial performance. Starting with the 500 companies in the S&P index as our universe, we compared the one- and three-year record each has turned in for sales growth, net income growth, and total shareholder returns. We also looked at last year's profit margin and return on equity. (For a more detailed look at how we compile the rankings, see page 78.)
Add it all up, and the resulting rankings gave us the creme de la creme--the BW 50. Over the last three years, these companies have bested rivals. Those Performance Rankings, which include a detailed look at how each company fared on individual criteria, start on page 91.
Of course, it's also important to compare companies with industry peers. In some cases, superior management teams have bucked dismal industry growth rates to post supercharged overall performance. That's why we've also included extensive Industry Rankings, which include the actual growth rates upon which our Performance Rankings are based. Those tables also include sales and profit figures, as well as such shareholder information as recent share price, price-earnings ratio, yield, and earnings per share. Industry Rankings begin on page 123. An alphabetical index of the S&P 500, with company ranking by market value, sales, and profits, begins on page 150.
Those tables provide a look at what it takes to succeed in Corporate America--and how hard it is to stay on top. Of the top performers on last year's BUSINESS WEEK 50, fully half fell off and were replaced by new companies this year. In part, that's because the S&P is itself a changing universe; the composition of the index changes from year to year. In 1997, for example, S&P replaced 29 companies in the index--and 10 of the newcomers shot straight to the head of the class. Among them: advertising giant Omnicom Group, Wall Street powerhouse Lehman Brothers Holdings, and HBO & Co., which sells health-care information systems.
But just as important, other entrants emerged that reflect the changing fortunes of America's corporations. Thanks largely to a global exploration boom, oil services giants Schlumberger and Halliburton Co. rocketed onto this year's top 50. The ability of Home Depot Inc., the fixer-upper's paradise, to keep churning out strong and steady growth as it enters new domestic markets won it a spot for the first time. The tremendous turnaround at US Airways helped lift it to the No.2 spot in total returns--and 14 overall.
Equally interesting, of course, are those that fell off. Last year's No.50, hospital company Columbia/HCA Healthcare Corp., slid to No.457 as it took a big charge against earnings amid a government investigation of its billing practices, which sent profits down 88% and shareholder returns tumbling 35%. Problems in Asia flattened once mighty Nike Inc., which dropped from No.7 to No.64. Coca-Cola Co., which gets 80% of its sales and earnings overseas, was also hit hard by the persistently strong dollar. With sales growth nearly halted, it slipped from No.25 to No.119.
So who came out ahead? Thanks to the combination of a still strong bull market and a global M&A boom--not to mention a run of dealmaking by the industry's main players--brokerages and other nonbank financial companies grabbed 13 spots on the BW 50, the most of any industry. With investment banking and underwriting fees soaring, Merrill Lynch & Co., No.19, stood out: It earned $30 million on the $31 billion merger of Bell Atlantic Corp. and Nynex alone.
ANOMALIES. Thanks to the Internet, worldwide growth in business computers, and an increasing PC presence in homes, makers of computers, software, and other office equipment hogged nine spots on the list. Intel took one more.
Yet if being in a hot industry helped, it was rarely enough by itself to lift laggards to the top. Intel's ability to boost the performance of its chips, even as it cuts manufacturing costs, may keep it near the top, but rival Advanced Micro Devices Inc. weighs in at a lowly No.474. Despite having a microprocessor that is challenging Intel's dominant Pentium line, AMD lost money because it couldn't lick production problems. And despite a boom in credit that has buoyed much of the rest of the financial-services industry, Green Tree Financial Corp. fell victim to its own aggressive accounting. No.19 last year, it slipped to No.150 as its stock and earnings melted in the wake of a $190 million write-down.
Much like last year, the 1998 BW 50 crop contained its share of surprise newcomers. The list includes some dynamos you probably didn't know existed, from truckmaker PACCAR to mortgage banker Countrywide Credit Industries Inc..
Like all such lists, the BUSINESS WEEK ranking has anomalies. One thing to keep in mind as you check out the tables: Companies recovering from a down year can show a big jump in net income that makes them look better than they really are. Take Humana Inc., the big health maintenance organization. It tops our one-year profit growth list with a 1,342% increase. Looks impressive, until you consider that the company's 1996 earnings were almost completely wiped out by a $130 million charge--providing a very low base on which to improve. That's why we've included three-year performance numbers as well--and this is definitely one case where the longer view is invaluable: Humana's average profit change over three years is -24.5%.
A shift in corporate strategy can also alter the rankings. Companies that went public or were spun off less than three years ago don't register on the BW 50 radar screen, because they simply don't have enough data yet to allow for fair comparisons. AT&T spin-off Lucent Technologies Inc., for example, hasn't been independent long enough to be judged on its three-year stock performance. Meanwhile, companies such as AT&T that do the spin-offs sometimes slide down the list as sales and earnings shrink.
Taken as a whole, however, the Performance Rankings provide valuable insight into the forces which are transforming Corporate America. You don't have to go far down the list before hitting one of the biggest: Fueled by stiffening global competition and consolidation at home and abroad, many U.S. companies are using mergers to ratchet up the growth. After racking up deals worth a record $912 billion in 1997, an additional $196.2 billion worth have already been announced this year. "We see no loss of momentum," says Jack Levy, head of M&A at Merrill Lynch. "CEOs and boards today are so keenly focused on establishing a No.1 or No.2 position in their industry."
M&A BOOST. That was certainly the case with Morgan Stanley's $10.6 billion combination with Dean Witter, Discover & Co. The desire to improve distribution was the main draw for the deal, which pushed the company up into the No.10 slot. Not only can initial public offerings underwritten by Morgan Stanley now be sold through both firms' brokers, but the promise of a broader customer base has helped the company increase its share of worldwide equities underwritings, from 7.3% to 9.4%, since the deal closed. "It gave us incredible revenue growth," says CEO Philip J. Purcell. Indeed, sales grew 22% last year, capping a strong three-year streak in which investors watched total returns rise 262.5%.
For many of the smaller firms in the S&P 500, mergers have also proven a quick way to bolster product lines. Take Clear Channel Communications Inc., a little-known owner of billboards, radio stations, and TV channels which made $3.5 billion in acquisitions last year. The crowning touch was its $1.1 billion purchase of Eller Media, which moved the budding media empire into the billboard market. The company's ability to offer packages of radio and billboard advertising has now become a key competitive advantage, says CEO L. Lowry Mays. It has certainly paid off: Clear Channel's resulting 98% sales spurt was the biggest one-year gain of the entire S&P 500.
INTERNAL ENGINE. But not every company on the BW 50 went looking beyond its own doorstep for prospects. Many others have proven masters at generating growth internally. Perhaps none exemplifies that better than No.2-ranked Dell, where ultra-efficient manufacturing underpins its ability to move rapidly into new markets on its own. Founder Michael S. Dell supplies custom-made machines directly to buyers, stripping out the costs of inventory and retail distribution. Dell's skimpy one week of inventory--just one-tenth that of rivals--gives the company a 10% to 15% cost advantage over rivals. The fast sales growth that results has allowed Dell to easily outrank all other comers in shareholder returns: Its phenomenal 299% leap was topped only by the stunning 2,596% gain that Dell has racked up over three years.
But that single-minded focus--and the intense drive it takes to stay on top--isn't limited to those in the high-tech world. It permeates the ranks of the BW 50, perhaps nowhere more so than at No.41-ranked General Electric Co. CEO John F. Welch, 62, may be in his 17th year at the helm of the conglomerate, but he's hardly counting his days until retirement. Indeed, the legendary CEO remains as intense as ever in his push for ever higher growth. The result: Though GE, with $91 billion in sales, is more than twice as big as the next largest company in the BW 50, it's growing faster than many a sprightly small firm. Sales rose an impressive 15% last year as net income jumped 13%. Shareholders have reaped the rewards--a 203.4% return over the last three years.
In part, GE's surprising agility stems from a shift the company has made to take ever more advantage of global markets and to move away from manufacturing in favor of higher-margined services. But no matter how big it gets, Welch also makes sure that GE execs continue to sweat the small stuff. Over the past two years, GE has become immersed in a companywide quality program called Six Sigma; by reducing manufacturing and product defects, Welch figures GE can save hundreds of millions in costs. "Six Sigma has spread like wildfire across the company, and it is transforming everything," says Welch.
That's one approach to generating strong internal growth. For U.S. drugmakers, success has come from a heavy commitment to research and development and a massive distribution network. The appearance of three pharmaceutical giants on the BW 50--No.11 Schering-Plough, No.12 Pfizer, and No.15 Merck--is due largely to their ability to turn out a steady stream of hot new drugs. Continued high levels of new drug rollouts this year, thanks to a faster approval process at the Food & Drug Administration, should help many pharmaceutical companies keep margins high and growth rates in double digits.
And Pfizer, for one, has also shown that it knows how to innovate outside of the lab. Having built up a potent sales force to serve up its own new drugs, it has leveraged its marketing skills by signing deals to help other companies sell promising new products. In so doing it ensures its margins remain stellar. Take its successful joint marketing venture with Warner-Lambert Co. for cholesterol reducer Lipitor. Developed by Warner-Lambert and introduced to the market in February, 1997, Lipitor is also sold by 1,200 Pfizer salespeople. Today, it has become the most successful drug introduction ever--and Pfizer gets a cut of the sales. "Our whole strategy has been growth through innovation," says CEO William C. Steere Jr. "Not just in research but innovation through clinical development and marketing activity."
Many of our superstars also got to the top by focusing intensely on meeting customer needs. That's the case at Gap Inc.: The combination of marketing prowess with a never ending study of its customers has allowed the San Francisco-based clothier to become one of three retailers to make it to this year's BW 50. Sure, the strength of America's shift to casual wear helped fuel the sales and earnings boom that has lifted Gap to No.17. But CEO Millard S. Drexler has also been hugely effective at slicing the market with the company's Gap, Banana Republic, GapKids, and Old Navy stores. By aiming the chains at different age and income groups, he has been able to attract a strong following for each. While the rest of the clothing store industry struggles with overcapacity, Gap keeps opening up new locations. Over the last three years, sales have grown an average 20.4%.
Maybe it's not revolutionary that a retailer listens to its customers. But the success of No.13-ranked Applied Materials is also founded on believing the customer is always right. The leading manufacturer of chipmaking equipment, with market shares ranging from 30% to 60% in several key areas, it involves customers every step of the way in the development of new products.
A few years ago, when CEO James C. Morgan became interested in supplying systems that make computer flat-panel displays, his Japanese team was able to persuade Sharp Corp. and Toshiba Corp., long-term customers but archrivals, to share their knowledge of flat panels. That helped Applied Materials efficiently enter a whole new market, while rapidly giving the Japanese companies the equipment they needed. "That close a relationship--it's built over a long period of time," Morgan says.
SINGLE-MINDED DEVOTION. Those kinds of gains only come when a company knows its own markets and customers well--and focuses intently on them. That's why its no surprise that a single-minded devotion to core markets is another feature of many of our performance champions. Few demonstrate that better than Tellabs Inc. of Lisle, Ill., which moved up to No.7 from No.21. The maker of digital network-switching equipment decided years ago to concentrate on equipment that is used to direct data, video, and voice signals from one telephone company's lines to those of another. With pressure mounting on local phone companies to open their networks to competitors such as the long-distance carriers, Tellabs finds itself "in the sweet spot of the business," says CEO Michael J. Birck.
Tellabs' earlier decision to concentrate is now paying off in spades, as it holds off much larger rivals such as Northern Telecom Ltd. and Lucent. "We're much more specialized," says Birck. "Maybe that focus has given us a competitive advantage." It certainly seems so: Tellabs, with $1.2 billion in sales, boosted profits a sizzling 124% last year, even as service providers such as MCI Communications Corp. and AT&T lost tens of millions of dollars. All told, the company has averaged annual profits hikes of 47.7% over the last three years, while shareholders rang up an eye-popping 364.4% return.
In a very different market, Charles Schwab Corp., No.31, also demonstrates the gains to be reaped from seeing a growing market niche and positioning your company to take advantage of it. Throughout the long-running bull market, Schwab has set itself up as the low-cost financial-services provider of choice for millions of Americans.
By offering everything from online trading and a funds supermarket to advice for befuddled investors, the discount broker has kept sales humming at a steady 30.8% a year since 1994. "Obviously we have had the wind at our back," says David S. Pottruck, Schwab's co-CEO. And if it shifts? Pottruck admits a sustained market decline will hurt Schwab's growth but says it will adapt: "People are always going to want to manage their money and look to the future."
They won't be the only ones looking ahead. Indeed, for investors, as for some of this year's BW 50 stars, the future has already grown murky. With sub-$1,000 PCs now driving growth in the computer market, stars such as Compaq and Intel will have their mettle tested in the year ahead. Intel shocked Wall Street when it warned in March that first-quarter revenues would slip below those of a year earlier for the first time in a decade. The culprit: Those cheap PCs leave no room for the $250-plus microprocessors that have kept Intel's margins at their traditional sky-high levels. And with a glut of higher-priced machines to unload at a discount, Compaq recently announced that 1998 profits will probably fall 25%.
Still, Compaq CEO Eckhard Pfeiffer insists the reversal is temporary. Promising to be on track by midyear, he's sticking to plans to double revenues by 2000. "We'll continue our aggressive market share strategy," he says.
Brave talk? Perhaps. In any case, it's inevitable that some big names will drop from the BW 50 ranks next year. So who will come out ahead a year from now? It's far too early to tell. Few could have predicted the fall of Coke or Nike a year ago, or the surprising rise of Clear Channel since. But armed with a wealth of information on the performance of the 500 most watched companies in America, investors can see which management teams have found their way to the winner's circle today.