We've made two big changes in drafting this year's Hot Growth ranking. The first: We now compare each company's performance with the performance of larger companies in its industry. That reduces the impact of sector-specific shocks, such as high oil prices. The second: We used a tighter screening process, so we've ranked only 50 companies, as opposed to 100 in years past.
We began with Standard & Poor's (MHP) Compu-stat database of 10,000 publicly traded corporations. Next, we screened for companies with a minimum stock price of $5 (as of Mar. 31, 2008), a market value of at least $25 million, and sales between $50 million and $1.5 billion. As always, we excluded banks, insurers, and real estate investment trusts, as well as the highly regulated utilities sector.
Next, we identified companies with one- and three-year sales growth at least 30% higher than the average measures for the corresponding S&P 500 sector. Also, companies' return on invested capital (ROIC) in the most recent year had to equal or beat the ROIC for their sector. ROIC is net income available to shareholders as a percentage of the value of invested capital—basically, long-term debt and shareholder equity. In measuring ROIC, S&P Compustat excludes distortions from extraordinary items and discontinued operations.
The third screen identified outfits truly on an upswing relative to their sector. Companies had to pass a test: Either one-year profit growth had to be at least 30% higher than the corresponding S&P 500 sector average, or one-year total return had to be at least 30% higher than the sector's average.
We ranked the remaining companies by a combination of ROIC and three-year sales growth, each metric adjusted for the performance of the corresponding S&P 500 sector. Finally, since numbers don't always tell the whole story, we used our editorial judgment. We excluded or adjusted the rank of companies with extended stock price declines or other red flags that raise questions about future performance. —Michael Mandel
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