Vetting the BW 50's Investment Potential

Given the often poor showing of growth stocks during a downturn, we ran two screens to gauge the possible stock performance of the companies in the BW 50

by Dean Foust

The companies that make the BusinessWeek 50 are truly a cut above the rest when it comes to their operating performance, but how do these companies fare as investments? It's a good question. The answer: It depends.

That's because the proprietary screen we use to rank the companies in the Standard & Poor's 500-stock index by their performance—and then use to anoint the top 50 companies in that ranking as the BusinessWeek 50—rewards companies that are growing the fastest. During bull markets, growth stocks do well—and that was the case with the BusinessWeek 50 companies during the Roaring '90s when they regularly outperformed the major indexes the year after they were named to the list.

But growth stocks fare poorly during grinding markets—and particularly during recessions. That was the fate of the BusinessWeek 50 during the last recession: The 50 companies we anointed in March, 2001, on the cusp of the short economic downturn, saw their stocks plunge an average of 23.7% over the next 12 months, compared with a modest 3.7% dip for the Dow Jones industrial average and a 10.7% drop in the S&P 500.

All of which suggests that if the U.S. is indeed teetering on the edge of a brutal recession, now is not the time to blindly buy up the companies on our list. Already, some of our top honorees have suffered steep drops in their stocks—our No. 1 performer, Coach (COH) (BusinessWeek, 3/27/08), has seen its shares plunge 35% on fears its customers will cut back on purchases of $400 handbags—and there's no guarantee further declines aren't ahead. But as Wall Street pros love to say, it's a market of stocks, not a stock market, and given the operational excellence displayed by the companies in the BusinessWeek 50, this list can be a good place to start.

Sliced and Diced Two Ways

To identify the best investment plays from the BW 50, we ran the companies through two screens, all with the assistance of Standard & Poor's Compustat (like BusinessWeek, a division of The McGraw-Hill Companies (MHP)). Working under the assumption that the next couple of years could be tough for investors, we decided to construct two screens that would pull up those companies with the resources to weather both a recession and banks' potential reluctance to provide financing to anyone other than, well, companies that probably don't need the money anyway.

The first screen was designed to screen for value stocks, specifically those companies with a balance sheet strong enough to weather any coming economic storms (although since the BW 50 is at heart a growth list, you can assume that all of these companies have demonstrated strong, steady growth in recent years). And for investors willing to take on just a little more risk in search of higher returns, we also offer a second screen that is designed to mimic the philosophy of the greatest investor of the modern era, Warren Buffett.

Value Stock Screen

In our search for value stocks of companies with sound financial footing, we decided to look for companies with strong cash positions that will tide them over if the credit markets remain tight for the next year or two. But since the companies in the BW 50 vary wildly in size—IntercontinentalExchange (ICE) (No. 13) recorded $574 million in revenues last year, an amount that ExxonMobil (XOM) (No. 50), with $468 billion in sales, brings in before noon on any given day—we divided each company's cash holdings by the number of outstanding shares, producing a cash-per-share figure. Then we excluded any company whose cash-per-share holdings were below the average among the S&P 500 companies. That culled the herd to 11: Allegheny Technologies (ATI) (No. 3), Apple (AAPL) (No. 6), UnitedHealth Group (UNH) (No. 14), CME Group (CME) (No. 15), Goldman Sachs Group (GS) (No. 21), Amazon.com (AMZN) (No. 23), Nucor (NUE) (No. 25), Lehman Brothers Holdings (LEH) (No. 33), Google (GOOG) (No. 34), PNC Financial Services Group (PNC) (No. 38), ExxonMobil, and Sunoco (No. 20).