The Business Week 50: Finance Muscles Its Way To The Top

A report card on the BUSINESS WEEK 50 reveals a shift that includes big industrials, too

For executives at Capital One Financial, the recent turn in the stock market has been a breath of fresh air. While the credit-card issuer's sales and earnings growth have been hot for years, its stock languished in 1999 as interest rates headed higher. But over the past six months, financial stocks have soared. Capital One shares rose 60% as investors became increasingly confident that the Federal Reserve's rate hikes were coming to an end.

Stabilizing interest rates are only part of the story behind Capital One's buoyant stock price. The company is being rewarded for its deft manipulation of data, which allows it to match the right customers with the right credit-card offer. In the second quarter alone, Capital One added 1.8 million new accounts, up 7.2% from the first quarter. The company is also making big strides on the Internet and is on track to originate nearly 1 million cards online this year. "Our competitors are struggling with undifferentiated products while we deliver a customized card to every customer," says Capital One Chief Executive Officer Richard D. Fairbank.

Since we formed the latest BUSINESS WEEK 50 list of top-performing companies last March, a renewed ardor for financial-services companies such as Capital One, as well as for some industrial giants such as General Dynamics, has helped power the group's stock market performance. The vibrancy of those sectors offset a pounding of some high-tech companies atop the list. Investors in recent months pulled back from those tech stocks as they fretted about sky-high valuations and a potential slowdown in computer spending.

Thanks to its eclectic mix, the BW50 managed to outperform the broader market. From Mar. 1 through Aug. 31, the BW50 racked up stock gains of 11.6%, compared with a 10% return for the Standard & Poor's 500-stock index. The BW50 also edged out the Dow Jones industrial average, which was up 10.6% for that six-month period. Not surprisingly, the BW50 swamped the tech-heavy Nasdaq Composite index, which was down 12.1%.

That market-topping performance reflects some powerful fundamentals that we target with our selection process. The BW50 companies were chosen from the S&P 500 based on top-tier sales growth, earnings growth, and shareholder returns over one-year and three-year time frames. Net margins and return on equity were factored in, reflecting how efficiently the companies are run. Those results were weighted by total sales for each company--a recognition that the larger a company is, the more challenging it is to generate high growth rates.

IMPROVEMENTS. To better capture the impact of those bigger players, we changed how we measure the BW50's stock performance this year. Previously, we just put one share of each company into a basket and measured the group's performance. But in March, we began weighting the returns of each company by its market capitalization.

Our emphasis on growth has traditionally given the BW50 a tech-heavy weighting. But at the midway point of this year, just one of the top 10 performers is a tech stock: data-storage giant EMC. "It's not that the technology revolution isn't coming to fruition," says William E. Dodge, president and chief investment officer of money manager Delaware Investments. "It's that expectations had gotten way ahead of themselves."

Investors responded by shifting their focus to other sectors--especially finance, which accounted for 4 of the top 10 stock performers. Another credit-card player, MBNA, was up 53% in the six-month period. MBNA's savvy marketing of affinity cards to groups such as NASCAR racing fans--whose purchases earn points that they can use for NASCAR merchandise--continues to drive torrid growth, with net income over the past six months up 26%, to $520 million. Meanwhile, banking giant Citigroup, a newcomer to the BW50, also helped lift the overall group. The stock rose 51% from March through August, reflecting a 37% rise in net income, to $6.6 billion, over the first half of 2000. Citi was fueled by internal growth and acquisitions such as Diners Club Japan and London investment bank Schroders. Citi missed the list last spring but climbed on when drugmaker Warner-Lambert, No. 9, was bought by Pfizer in June.

Heavy industry also got renewed attention on our list. This summer, when Kansas City Southern Industries spun off its high-profile financial arm--including Janus Capital--as Stilwell Financial, most investors bailed out. They had been aboard purely for the mutual-fund play. But by Aug. 31, the railroad's stock was up 100% over its March adjusted price. It helps that Kansas City Southern holds a 49% interest in Transportacion Maritima Mexicana, which owns the main railroad line between Mexico City and Laredo, Tex. That may be the fastest-growing industrial area on the North American continent. "They are, in essence, the NAFTA railroad," says Douglas W. Rockel, a transportation analyst at ING Barings.

DIVERSIFYING. Reliant Energy nabbed the No. 2 spot, with its stock rising 81% as sweltering heat in many parts of the country and a booming economy sent electricity demand soaring. Reliant is also being rewarded for transforming itself from a slow-growing electric utility into a diversified supplier of nonregulated wholesale energy and a trader of natural gas and power. "While several companies are attempting to do this, we are beginning to show results," says Reliant Vice-Chairman Robert W. Harvey.

Of course, some tech companies managed to post decent stock gains. The winners include Intel and Oracle--stalwarts that have seized new markets. Intel, up 29%, is pushing its microprocessors into everything from high-powered computer servers to networking gear, while Oracle, up 27%, has tailored its software to be Net-ready.

Still, most tech stocks suffered a rough fall to earth. Consider Microsoft, which in March captured our top spot for the third straight year. Slower demand, followed by component shortages, hurt sales of business PCs over the past year, keeping a lid on sales of Windows 2000 software. And the June court ruling that Microsoft should be broken in two--which the company is appealing--has investors sweating. The giant's stock fell 23% over six months.

The tech companies that took the biggest beating were those that failed to live up to Wall Street's expectations. Telecommunications giant Lucent Technologies slid 39% as it fell behind rivals such as Nortel Networks in the critical optical-networking market. And while wireless company Qualcomm was the top-performing stock on our list back in the spring, its price has since slipped 57% after it became clear that many phone carriers will not adopt the technology standard Qualcomm pioneered for their next-generation systems.

If the economy slows in coming months, the going could get even tougher for stocks that are tied directly to consumer spending. Shares of Gap, the casual-clothing chain, lost 54% of their value from March through August as the company endured a series of logistical headaches and fashion stumbles. The company's comeback attempt will be much harder if consumers start tightening. Still, the record indicates that when one of the BW50 runners stumbles, someone else on this roster of overachievers usually finds a way to step up the pace.

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