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2001 BW 50



The Best Performers
When the recession punctured the bubble, many highfliers crashed to earth. Nowhere is that more evident than in this year's BW50

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For Corporate America, 2001 was the cold shower after one of the dizziest, giddiest binges in business history. The late 1990s were a time when almost any manager could feel like the next Jack Welch. With the economic boom leaving even mediocre corporations awash in record profits, many companies--and the executives who ran them--were lulled into a dangerous sense of invincibility. The stock markets seemed only to go up, consumer confidence and spending were at vertiginous levels, and the country was floating on a New Economy high. Bet big on acquisitions? Create new "pro forma" profit measures? Why not? Anything seemed to go in the go-go '90s.

When the recession punctured the bubble, many highfliers of the past decade came crashing back to earth. And nowhere was this brutal shakeout more evident than in this year's BusinessWeek 50, our sixth annual ranking of the nation's best-performing large public corporations.

At the height of the 1990s boom, the BW50 was dominated by a new generation of companies. Chief among them were the tech outfits providing the building blocks for the New Economy, companies such as Microsoft (MSFT ), Dell Computer (DELL ), Cisco Systems (CSCO ), and Intel (INTC ). Now that the party is over, many of those companies have had to settle for more down-to-earth growth rates and stock valuations that have knocked them out of our ranking. "A lot of tech companies will never be on the [BW50] list again," says Steven Wieting, a senior economist at Salomon Smith Barney.

After accounting for nearly half of the BW50 two years ago and garnering 16 spots last year, only three tech and telecom companies made this year's list: KLA-Tencor (KLAC ) (No. 6), First Data (FDC ) (No. 44), and Electronic Data Systems (EDS ) (No. 48)--all newcomers to the list. Altogether, only 17 companies from the Class of '01 are making a repeat appearance on the 2002 roster.

Indeed, the one-two punch of the recession and the implosion last fall of energy trader Enron Corp. have resulted in one of the most dramatic changes in the composition of the BW50 since its inception in 1997. To see just how dramatic, you don't have to look further than the No. 1 berth. Last year's performance champ, serial-acquirer Tyco International Ltd. (TYC ), has seen its stock plunge amid questions about its accounting. No. 1 this year: the 116-year-old Johnson & Johnson (JNJ ), which catapulted from No. 104 last year on the strength of its brands, its marketing, and its farsighted management team.

That reshuffling of the deck has made the Class of '02 a far more diverse group than earlier rankings. While they can't all claim the turbocharged growth rates the tech stars posted at their peak, this year's group performs an even more impressive feat: demonstrating an ability to prosper in both good times and bad. "You have to look very hard to see any sign of recession in [our] credit-card portfolio," boasts Richard D. Fairbank, chief executive of credit-card lender Capital One Financial Corp. (COF ), No. 47 on this year's list. What is the secret for recession-proof performance? By and large, this year's stars steered clear of the faddish telecom deals, trendy agglomeration, and hyperaggressive accounting techniques that have come back to haunt so many of the companies in earlier rankings.

Instead, the Class of '02 is maintaining a tight strategic focus on their core businesses, be it selling stereos or making mortgage loans. Like the best companies always have, they lavish attention on the myriad small details that make up a business, always looking for ways to make an improvement, no matter how minute.

In many instances, these efforts have helped them become the lowest-cost producers in their sectors. At First Data Corp., a Denver-based credit-card processor, CEO Charles T. Fote convenes a worldwide morning conference call with his 100 top lieutenants to discuss the previous day's performance--a feet-to-the-fire approach that helps ensure that problems don't fester. "You can only get away with a b.s. answer once, so if you give that answer on Thursday you'd better have a fix by Friday," says Fote.

BW50_totalreturn This changing of the guard resulted in a list of top performers that tilts away from the flashy growth companies of the bubble years and back to some of the stalwarts of the Old Economy. Put another way, this was the year that beer, bath towels, and Band-Aids became cool again. Consumer goods makers Philip Morris (MO ) (No. 5) and PepsiCo (PEP ) (No. 39) climbed aboard the BW50 list this year for the first time ever. Wal-Mart Stores Inc. (WMT ) ascended from No. 125 last year to No. 14, just as its sales surpassed those of ExxonMobil Corp. (XOM ), making it the largest company in the world. And the health-care sector, which placed only four companies in 2001, muscled in with 10 this year.

Many of these seasoned companies, were preparing for the downturn before the boom ended. "We saw this recession coming three years ago," says Johnson & Johnson CEO Ralph S. Larsen. That foresight allowed the company the luxury of overhauling some divisions and revamping operations at the ideal time--when it could afford to. Similarly, Pepsi's spin-off of its fast-food and bottling operations during the boom enabled it to redouble its focus on its profitable Frito-Lay snack division and allowed it to launch new products which Pepsi expects will boost revenues by $1 billion this year. "In a recessionary economy, innovation is as important or more important for products like ours," says CEO Steven S. Reinemund, who foresees Pepsi's per-share earnings climbing 13% to 14% this year.

BW50_sales With consumer spending the bright spot in the economy, it is not surprising that a lot of newcomers to the roster have a strong consumer focus. In the financial-services sector, dealmakers such as Lehman Brothers Inc. (LEH ), which carried the torch in 2001, gave way to such consumer-oriented lenders as Freddie Mac (FRE ) (Federal Home Loan Mortgage) (No. 2) and Washington Mutual (WM ) (No. 29), which benefited both from interest-rate cuts and the public's insatiable demand for housing. Two of the newcomers--AmerisourceBergen (ABC ) (No. 10) and International Game Technology (IGT ) (No. 46)--weren't eligible a year ago; they were added to the S&P 500 only in the past year.

Our BW50 index surged ahead of most indexes when the market was booming. But it has fallen faster and harder on the way down. For the year ended Feb. 28, the index lost 23.7%, exceeding even the 19.5% plunge by the tech-heavy Nasdaq composite. Meanwhile, the Dow Jones industrial average dipped only 3.7% during that period, while the S&P 500 fell 10.7%.

So what happened? Pure and simple, our ranking measures performance, with earnings growth, sales growth, and stock market returns all factored in. The shift en masse by Wall Street money managers from growth to value stocks hurt. So did the fact that like any performance ranking, our formula tended to reward companies like Tyco that bought their earnings through large-scale acquisitions, or, like Providian Financial Corp. (PVN ) (No. 6 last year), may have pushed the envelope on aggressive accounting and lending. That said, as the economy and the markets stabilize, it's likely that companies with above-average growth will return to the top of the BW50 rankings. (To track this year's BW50, turn to the Figures of the Week page in the back of the magazine each week.)


BusinessWeek has periodically made modest refinements to the proprietary computer model used to select the BW50 from the companies in the S&P 500 (see page 40 for details on how the rankings are developed), and we have continued tweaking. This year, we gave slightly more weight to absolute sales. It's a way of recognizing the increased difficulty big companies have of maintaining large percentage gains as they grow.

We made one other important change this year: We exercised our editorial judgment and excluded five companies from the rankings because of significant questions about their accounting. Qwest Communications International (Q ), WorldCom (WCOM ), Nvidia (NVDA ), PNC Financial Services Group (PNC ), and Computer Associates International (CA ) face questions on issues ranging from accounting for reserves to off-balance-sheet debt. All have recently disclosed that the Securities & Exchange Commission is investigating their accounting. With these questions unresolved we felt we could not include the companies in our ranking.

Qwest, Nvidia, and WorldCom declined to comment. But in a letter to BusinessWeek, Computer Associates was forthright about its displeasure: "Excluding our company from the rankings on the basis of an inquiry--not even on a claim of some impropriety--implies wrongdoing. Branding someone in this fashion is unfair and contrary to one of the fundamental tenets of our society." Meanwhile, a spokesman for PNC says, "PNC has already revised 2001 earnings to reflect the accounting issues that arose. There has been no impact on the fundamentals of the company. Our balance sheet is strong and our business is solid."

Serious accounting questions have been raised even for some companies that made this year's BW50. Energy traders such as Calpine (CPN ) (No. 20) and Dynegy (DYN ) (No. 15), for example, have come under intense scrutiny by investors. Calpine responded by providing more disclosure about its accounting, while Dynegy scaled back capital spending and moved aggressively to shore up its balance sheet. Tyco, whose accounting practices were examined by the SEC two years ago--with no adverse findings--may be one of the most examined companies in the U.S. While Tyco certainly skates close to the edge, there is no sign yet that it will have to take a big write-off before plans to spin off its plastics business and its finance unit, CIT Group, are completed. But investors extracted a huge price from Tyco for its complex and sometimes controversial accounting--and for revelations that Tyco paid $10 million to the director who arranged the CIT takeover: Tyco's stock returns have plunged 46.7% in the year ended Feb. 28, 2002. Tyco ranked No. 1 last year. This year's showing? A far less lofty No. 45.

Even some of the companies on this year's list that aren't being forced to answer questions about their books are in investors' crosshairs--and may not make the list next year. Mighty Merck & Co. (MRK ) --which, in 40th place, is the sole surviving company to grace the BW50 all six years--is in jeopardy of snapping that streak next year. CEO Raymond V. Gilmartin has told Wall Street that Merck's earnings are likely to be flat in 2002 because several of its blockbuster drugs have gone off patent and its new-drug pipeline looks weak.

BW50_netmargin The class of 2001 may not have the eye-popping numbers of the tech darlings of a few years ago, but many have demonstrated an impressive consistency. Many are dominant players in their industries. While their rivals struggle to work off the excesses of the past decade, some BW50 companies are using the economic lull to widen their lead over the pack.

Edward M. Kerschner, chief investment strategist at UBS Warburg, particularly likes three of the 50--Duke Energy (DUK ) (No. 30), Bed Bath & Beyond (BBBY ) (No. 32), and Capital One Financial--because, he says, they are well positioned to take advantage of their rivals' mistakes. "As the placid waters of prosperity recede, the ugliness of bad loans and poor investment decisions suddenly becomes visible," says Kerschner. Translated: Such companies as Duke and Capital One are poised to poach their rivals' best workers, squeeze better terms out of suppliers, and in some cases snap up choice assets being divested by struggling competitors.

BW50_returnonequity If any company epitomizes Kerschner's theory that the rich will get richer, it's Bed Bath & Beyond Inc. Unlike other home furnishing chains that have expanded by taking on heavy debt loads, the Union (N.J.)-based retailer funded its expansion out of cash flow. Smart move, because Bed Bath is now positioned to leave the competition in the dust. Lechters Inc., which filed for bankruptcy last year, is liquidating its 315 stores. HomePlace Stores of America, formerly the third-largest chain in the home decor sector, ended up shutting its 84 stores last year. By contrast, Bed Bath, which now has 396 stores, plans to add another 90 locations this year--and it's getting its pick of prime real estate. The upshot? "Our competitive position has gotten much, much stronger," says Bed Bath co-Chief Executive Warren Eisenberg.

One thing Bed Bath isn't buying is other retail chains. It's now painfully clear that many BW 50 alumni that tried to buy their earnings through frenetic dealmaking, such as Tyco, WorldCom, and Cisco, are now suffering because of it. The results were especially bad when companies struck deals outside their core competency. That was the case for many of the companies that tried to strike it rich in the telecom boom. Chris Zook, head of Bain & Co.'s worldwide strategy practice, notes that of 72 major investments in broadband and other telecom services by utilities and energy companies that sought to use their existing fiber-optic networks to generate new revenue streams, only a half-dozen have panned out. Indeed, most of the companies from the sector that made this year's BW50--including Dynegy, Duke Energy, and American Electric Power (AEP ) (No. 35)--"avoided the siren song of telecom," says Zook.

Yet with all the consolidation still anticipated in the energy, tech, and telecom sectors, this year's BW50 companies provide a lot of clues on how to do deals right. First, target companies that offer opportunities to cut costs. Then, carefully manage the harder task of integrating the new company. Consider Pfizer Inc. (PFE ), whose No. 3 showing this year was largely the result of its $114 billion acquisition of Warner-Lambert Co. two years ago. In hindsight, even Pfizer CEO Henry A. McKinnell admits that swallowing a company the size of Warner-Lambert was a tall order. "Pfizer had never done a merger on that scale," he says, adding "our execution ability has been proven."

McKinnell began by slashing $1.4 billion in costs by the end of 2001. But the real payoff came from pumping some of Warner-Lambert's hottest drugs, including Lipitor, through Pfizer's well-honed marketing and distribution channels. In 2001, Pfizer spent $802 million on ads for such products as Lipitor and Viagra. The drugmaker employs an army of 8,200 sales reps in the U.S. and 15,000 more in international markets who are constantly feeding doctors the latest clinical data on products. The payoff: Since Pfizer gained control of Lipitor, it has boosted sales of the anti-cholesterol drug by 70%, to $6.4 billion. "I never thought they had the best pipeline," says Lehman Brothers analyst C. Anthony Butler. "But they are able to sell the dickens out of what they have."

At the height of the boom it seemed as if every company could sell the dickens out of what it had--especially the energy companies, which rode the surge in energy prices in 1999 and 2000 to record profits. But the subsequent collapse in prices changed that. Of the 13 utilities and energy companies that vaulted onto the BW50 roster in 2001, only seven survive in 2002.

One was Duke Energy. Its profits in 2000 climbed 110% over 1999 levels, but rose only 12%, year to year, in 2001. Nevertheless, that enabled Duke, No. 19 in last year's BW50, to eke out its 30th-place showing this year. While other merchant energy producers were juicing their profits by selling most of their output in the spot market, Duke's CEO, Richard B. Priory, insisted on signing customers to long-term contracts that were often below what Duke could earn on the spot market. But those deals provided a fat cushion when prices plunged last year. Now, with Duke's rivals weakened, Priory says he plans to "take advantage of the acquisition opportunities in today's market environment."

In fact, that kind of long-term thinking characterizes a lot of members of this year's BW50. It's a willingness to take risks and tackle simmering problems while times are good, rather than focusing just on the here and now. No. 1 company Johnson & Johnson is a good example. Although the New Brunswick (N.J.)-based maker of drugs and medical devices was doing well--growing annual profits at a double-digit pace--CEO Larsen knew that J&J's research labs needed an overhaul. So when a few promising drugs flopped in late-stage trials or were rejected by regulators, Larsen moved fast in 1999 to shake up J&J labs while times were flush: "It was obvious the booming economic cycle couldn't continue," he says.

Larsen replaced J&J's single-drug research teams with a more entrepreneurial system that created interdisciplinary teams of biologists and chemists to cut drug development times. The company also put a stringent new review process in place to decide whether to quickly pull the plug or move forward with new drug development. As a result, J&J now has 29 compounds in early development, vs. just a half-dozen five years ago. Larsen did that while putting big marketing dollars behind some of J&J's best-selling drugs, such as the $1.8 billion anti-psychotic drug Risperdal. It was good medicine: J&J's earnings rose a respectable 14% in 2001, to $5.7 billion, on an 11% rise in sales. With Larsen set to retire this summer, analysts believe his successor, William C. Weldon, is inheriting a company poised to vault past weaker rivals.

Preparing ahead for rough times also paid off for Capital One, one of the nation's largest credit-card issuers. As the economy began weakening in 2000, Capital One--which already boasted one of the lowest charge-off rates in the industry--became more aggressive about reining in its exposure to less creditworthy customers. "Risk management is key to our success," says CEO Fairbank. With go-for-broke rivals such as Providian Financial buckling under the weight of bad accounts, analysts say that Capital One is now positioned to snap up some of Providian's assets for a song. Adds the CEO, "We've gone from a specialty niche player in credit cards to a full-line company. Capital One is a very broad-based player in almost every segment of the market."

In many ways, success in 2001 meant paying close attention to the needs of the consumer. Like all homebuilders, KB Home (KBH ) (No. 43) was helped by low interest rates that kept sales booming. But KB demonstrated the power of a consumer-first approach in a business not traditionally known for its customer focus. A decade ago, KB churned out subdivisions using no more than four layouts--the same ones in Los Angeles that it used in Marin County, Calif. But realizing that today's buyers want more choice, KB now offers as many as 20 different floor plans within a single subdivision. And these days, it polls its customers to find out what they like. After 90% of buyers told KB that they didn't want a fireplace, the company got the message and now offers it as one of 5,000 options. "Instead of us dictating what our customers want, we use surveys to ask them," says CEO Bruce Karatz.

BW50_repeatperformers One of the beauties of capitalism is that companies can almost always get another shot at inventing themselves. And while the economy seems ready to shake off the recession, the combination of high consumer debt and deflationary pressures means that for much of Corporate America, growth may not come as easily as it did in the '90s. Companies that prosper will be those that maintain a keen customer focus and sharpen their operational skills to become low-cost producers. Those that do will fare well--perhaps even well enough to rejoin the elite of the BW50. Home Depot (HD ) did it. After falling to No. 118 last year, Depot vaulted back to No. 13 this year. A new CEO, General Electric Co. veteran Robert L. Nardelli, has reestablished discipline at the company, and with it new hope for the future. "Adding the next $50 billion [in sales] will require additional efforts, new tools, creativity," he says. "[But] there's clearly an infinite capacity to grow."

Whether in times of boom or bleakness, that's the rallying cry for the BusinessWeek 50.

MARCH 25, 2002

By Dean Foust, with Amy Barrett in Philadelphia, Brian Hindo, Frederick F. Jespersen, and Fred Katzenberg in New York, Mike McNamee in Washington, Aixa M. Pascual in Atlanta, and bureau reports

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