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2001 BW 50



After Enron, a Whole New Yardstick
How we adjusted for this year's difficult conditions

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To get a detailed sense of how the companies in the Standard & Poor's 500-stock index stack up, take a look at the accompanying tables. Between our performance rankings, with their letter grades, and our industry rankings, you'll find scads of data. These 500 stocks represent about 75% of the market value of all U.S. stocks. Our data can provide for the most sophisticated of reviews. We've been at the task of ranking these companies since 1997, but this year, the combination of recession and revelations of aggressive accounting at some formerly top-performing companies made the task more challenging than ever. Here's how we computed the rankings and how we adjusted for this year's unusual conditions.

First, of course, we measure sales growth, earnings growth, and total shareholder return for each of the 500 companies. Because we want to capture the outfits that have staying power, we tally each of those categories for one- and three-year periods. To get a read on how well management is employing assets, we factor in net margins and return on equity, both for one year. If any data are unavailable, a company receives an "incomplete" in that category. Because it's easier for small companies to score bigger percentage gains, we weight the results by sales volume. This year, we increased the sales weighting somewhat. Add it all up and you get a ranking for each company, with the top 50 making up our honor roll.

To compute letter grades for our performance rankings (page 60), we divide each measure into quintiles, with the top 20% of companies earning an A, the second 20% a B, and so on. We also present Industry Rankings (page 87) so you can evaluate each company against its peers. Our calculations are based on data available as of Feb. 28 and closing stock prices on the same date.

This year it became clear that some members of the class have been benefiting from grade inflation. The collapse of Enron Corp. has shed a harsh light on the aggressive accounting that was pumping up some bottom lines. That's why we decided for the first time that we couldn't take at face value some reported numbers. In a handful of cases, we elected not to rank companies because of questions about their financial statements, questions that were often accompanied by an investigation by the Securities & Exchange Commission. While we are not making a judgment on the quality of their accounting, we felt we could not rank those companies while these issues are unresolved. Instead, the companies are listed with their reported numbers, but are left unranked.

What kind of problems could knock you out of the rankings? Chipmaker Nvidia Corp. (NVDA ), for instance, would have placed fairly high up in the ranks of the BusinessWeek 50 based on its stellar one-year earnings and sales growth, and its stock returns. But the chipmaker revealed that the SEC is looking into how it accounted for reserves and whether it improperly shifted costs from one quarter to another. Qwest Communications International Inc. (Q ) was headed for a lower spot on the list until our own reporting raised serious questions about its accounting. The other S&P 500 companies that we excluded from the ranking for similar reasons are WorldCom (WCOM ), PNC Financial Services Group (PNC ), and Computer Associates International (CA ). All five companies have acknowledged SEC probes.

That's not to say that all the companies we did rank are spotless. In some cases, accounting questions have surfaced, but the issues seem less likely to shift the outfit's financial picture fundamentally. In other instances, companies face serious questions but the problems have been well-publicized and digested by investors.

Tyco International Ltd. (TYC ), the industrial conglomerate that topped the BW50 last year, is a good example. CEO L. Dennis Kozlowski has seen his growth-by-acquisition strategy implode as he battled investor suspicions that Tyco was pumping up its numbers with aggressive accounting. The SEC dropped its investigation of Tyco's accounting in mid-2000 without taking any action. And there has been no evidence to date that Tyco has violated generally accepted accounting principles. But that didn't reassure investors. Thus, while we didn't feel we had good reason to throw out Tyco, the market exacted its own rough justice: Tyco stock returned -46.7% from Feb. 28, 2001, through Feb. 28, 2002, helping to knock it from No.1 to No.45.

The rankings don't just reflect investor opinion, of course. They also help shape your view of corporate performance. With the markets unsettled and the economic future uncertain, we believe our rankings are more important than ever.

MARCH 25, 2002

By Robert McNatt in New York

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