These Alums Really Make The Grade

How last year's Hot Growth stocks fared

As frequent returnees to the Hot Growth list can attest, the key to staying hot is adapting to new trends without growing too fast. Few have done that better than Philadelphia-based retailer Urban Outfitters Inc. (URBN ), which has made an impressive six appearances on the Hot Growth 100. The 35-year-old clothing and lifestyle accessories chain, aimed at hip twentysomethings, has steadily expanded its reach, using cash -- not debt -- to grow to 78 stores. Urban also has carved out a lucrative niche with its 67-store Anthropologie chain, which deftly translates the cool Outfitters look to older females. Urban has been good to investors, too: Its stock has returned a phenomenal 495% over the past two years, making it the top performer of the Hot Growth Class of 2003.

Each year, as we prepare our rankings, BusinessWeek (MHP ) takes a look back to the Hot Growth class from two years before to see how well it fared. That leaves enough time to account for any short-term anomalies and to make fair comparisons with growth-oriented and broad indexes.

The results have never been better. Of the 100 companies on the 2003 list, 81 had positive returns, while just 16 produced losses for shareholders. (Three companies were merged or acquired.) Not even in the heady days of the late '90s did so many Hot Growth alumni perform so well. An investment in the Class of 2003 would have been a winner: As a weighted index, the group netted a return of 47%. That's right in line with the 49% gain of the small-cap Russell 2000 index, and it far outpaces a 31% return on the Standard & Poor's 500-stock index (MHP ).

That strong run reflects the favored status that small and mid-cap stocks have won over the past couple years. In 2003 small-cap stocks traded at a 40% discount to large caps on the measure of price-to-sales, estimates Richard S. Tortoriello, a Standard & Poor's equity analyst. That led value-hungry investors to pour money into small stocks. What's more, low interest rates helped growing companies to easily tap cash. "If small companies have decent credit access, that tells us their growth rates will be good," says Satya Pradhuman, chief small-cap strategist at Merrill Lynch & Co. (MER ).

It helps to develop a product or service that fills an unmet need. Las Vegas-based Shuffle Master Inc., which returned 147.5% for investors, makes a shuffling machine that allows casinos to deal more hands. Innovative players that can ease the burden of rising health-care costs have been rewarded handsomely, too. American Healthways Inc. (AMHC ), based in Nashville, has posted a healthy return of 202% since 2003, as insurers and big businesses clamor for its programs, which help workers manage costly diseases such as diabetes and heart trouble. "If you are a company that has proof it can drive down health-care costs, you will be highly in demand," says CEO Ben R. Leedle Jr.

A rising tide and favorable economic conditions are no fail-safe against growing pains, though. The worst performer on the Hot Growth list, 99 cents Only Stores (NDN ), grew too fast for its own good. As cash-strapped consumers flooded into the discount chain, its Los Angeles distribution center become overtaxed and inventory didn't reach stores. At the same time, local supermarket chains competed aggressively against 99 cents Only on pricing. The company's woes crystallized in April, 2004, when the stock tanked 30% after the retailer drastically reduced its financial outlook. Then Chairman David Gold had heart bypass surgery, spooking investors even more. Chief Executive Eric Schiffer did not return calls seeking comment.

Such cautionary tales were few and far between for the Hot Growth Class of 2003. In fact, three standouts are making their second consecutive appearance on our list of top ten alumni: Alliance Resource Partners (ARLP ), a coal producer riding the commodities boom; American Vanguard (AVD ), which sells a portfolio of pesticides; and Central European Distribution (CEDC ), which had the foresight to stake out part of the vodka market in Poland. A favorable market helps, but as the best Hot Growth performers show, execution matters more.

By Brian Hindo in New York, with Amy Barrett in Philadelphia

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