The Bw 50: Hey, Things Were Tough All Over
Back in March when we compiled the second annual BUSINESS WEEK 50, razor maker Gillette Co. looked hot. It was about to launch a revolutionary triple-bladed shaving device, the Mach3, and a steady sequence of double-digit earnings gains had sent its stock to a record high.
But by September, Gillette had slipped. Weakness in emerging markets--34% of its sales come from outside the U.S. and Western Europe--plus the costly ramp-up of the Mach3 had buffeted earnings and, in turn, the stock. Now trading at around 39, the consumer-products giant is down 37% from its 52-week high of 62.
Like many fast-growing companies with global ambitions, Gillette found out that what wowed investors last spring only made it a bigger target for those dumping shares in the summer and fall. Investors, stung by reports of cratering markets in Russia and Asia, have moved swiftly to cut overseas exposure, even if it means abandoning companies that have delivered years of solid earnings gains. That reversal has been particularly painful for the banks and other financial firms that rode the bull market, acquisitions, and low interest rates to tremendous gains in recent years--a performance that won them a prominent place on this year's BW 50.
HALF DOWN. The result: In the six months since we culled out a list of the best-performing members of the Standard & Poor's 500-stock index, the stocks of many of our growth companies have deteriorated. The BW 50's overall 9.5% decline was worse than the S&P 500's 7.2% drop but better than the Dow Jones industrial average, which fell 11.3%, and the Russell 2000 benchmark of small stocks, which lost 23.4%. Though many technology companies continued to do well, more than half of the 50 are posting lower stock prices than they were in March. (Both Standard & Poor's Corp. and BUSINESS WEEK are owned by The McGraw-Hill Companies.)
Of course, when you hitch your wagon to hot performers, as we did in creating the BW 50, there is a danger unforeseen events can send you tumbling. After six months, the average price-to-earnings ratio for the 50 stocks is 28, well above the S&P 500's average p-e of 24. That could expose these stocks to further sell-offs. But over the long term, investors still clearly expect outsize gains from the 50.
BRIGHT SPOTS. The list favors companies that consistently performed the best, based on improvement in sales, earnings, and total returns over a one-year and a three-year period. Two more ratings--return on equity and net margins--are added to measure how well management runs the business. Companies are also weighted by sales to acknowledge that it's easier to grow from a smaller base. Total performance for the group is calculated as if one share of each stock had been purchased. In the past, that's been a winning formula. Last year's BW 50 rose 24.7% in its first six months--vs. 16.5% for the S&P 500--and jumped 47.7% for the year, again outpacing the 500's 34.7% climb.
Even amid the gloom of the past six months, there were bright spots. Technology companies dominated the list of BW 50 winners. The top performer over the six months was Dell Computer Corp., up 85%. By combining lean manufacturing with smart marketing, Dell has so far rendered itself immune to the domestic slowdown. "They are expanding into new markets, there is no weakness in demand, the margins are stable," says Alan Bond, president and chief investment officer of institutional investor Bond Procope Capital Management.
Cisco Systems Inc. also continued its stellar run, jumping 44%. Outperforming rival computer networkers, Cisco bucked Asian woes in mid-September when it announced a 50% rise in sales to Singapore. Several other technology stars--EMC, Compaq, Microsoft, Sun Microsystems, and Intel--parlayed leadership positions into stock gains.
Others that defied the market doldrums capitalized on areas where the economy remains strong. Schering-Plough, maker of the No.1 allergy drug, Claritin, looked solid, as did Viagra manufacturer Pfizer. Strong consumer confidence helped Gap and Home Depot to double-digit stock hikes. And Guidant Corp., which makes a device used in coronary surgery, continued to steam ahead.
Indeed, for a while the BW 50 as a group looked as if it might weather the market turbulence quite well. As recently as late August, the BW 50 was leading all three indexes--the Dow Jones, Russell, and S&P 500--by a significant margin. But then global stocks tumbled and currencies dropped. The continued global financial turmoil has led to a rout in the shares of many finance companies. Since the BW 50 is weighted far more heavily toward those stocks than the broader market indexes, it was hit hard. Some 38% of the current BW 50--19 companies--are banks, insurers, and brokerages. That compares with 77 companies, or 15%, of the S&P 500. As a group, the financial stocks of the BW 50 fell 19.8% for the six months.
Brokerages such as Merrill Lynch, Travelers' Salomon Smith Barney division, and Morgan Stanley Dean Witter were among the most affected, as they racked up trading losses. By September, S&P had placed Lehman Brothers Holdings Inc., the smallest of the bunch, on Creditwatch with negative implications, and announced it would look into many of its brethren. Lehman, the worst-performing of the financial stocks in the BW 50, dropped 54% since March.
OIL, TOO. Not all the blame can go to the money sector, though. Stubbornly low oil prices pushed stock prices down 32.1% and more at oil service providers Schlumberger Ltd. and Halliburton Co. A profit warning on overseas turmoil and a slowdown in demand for Year 2000 fix-ups cut Computer Associates International Inc. by 41%. And the BW 50's biggest loser was Parametric Technology Corp., which makes engineering software. Its 69% decline stemmed from management mix-ups and a bumpy shift to an Internet-based product.
Will the next six months spell a rebound for the 50 or more pain? Daily market gyrations indicate continued volatility, if not a bear market. Indeed, the gap between the S&P 500 and the BW 50 has grown even wider in the past three weeks--as of Oct. 5, the BW 50 was down 16.9% from March 20, compared with a negative 10.1% for the S&P 500. The slide of financial-services firms was one factor, but the slump also caught up with some stronger performers--Guidant has given back almost all its gains, for instance.
Moreover, the wave of acquisitions that helped propel the stocks of industry consolidators seems to be dwindling to a ripple. Although a record $1.3 billion in deals have been announced this year, according to Securities Data Co., September stalled out at only $45 million.
These concerns, plus worries about the impact a not-so-merry Christmas shopping season may have on retailers and personal-computer vendors, will play out between now and next March, when we rejigger the list. But don't be surprised to see some of the same blue-chip stalwarts show up for the third year running. Analyst Laszlo Birinyi of Birinyi Associates notes that through all the recent gyrations, steady performers such as Dell and Microsoft have attracted investor dollars. "We continue to see the biggest interest in large, significant, well-known names," he says. In a market like this, you can't own enough of the winners--but, it seems, you also can't avoid owning some of the losers.