Cover Story: THE BUSINESS WEEK 1000
1995 WAS ONE FOR THE BOOKS
America's most valuable companies grew even more valuable--by a record 35%
For Cisco Systems Inc., 1995 was the year when all the chips fell into place. Corporations were suddenly racing to do more of their business across computer networks--including the Internet. And as the network traffic rose, so did demand for the switches that Cisco makes to manage the Net. Sales raced up 73% last year, to $2.7 billion, while earnings rocketed 94%, to $634 million. "Less than 1% of the world has Internet access," exults Cisco Chief Executive John T. Chambers. "We're in the very early innings of this game."
And up in the bleachers, investors are cheering: Cisco's market value soared 189%, to $26.3 billion. The hefty gain sent Cisco scrambling up this year's BUSINESS WEEK 1000, the annual roster of America's most valuable companies. Just 10 years old, the company now ranks No.40, surrounded by venerable titans such as Boeing Co. and 3M.
The fundamentals couldn't have been more different at Ford Motor Co., which spent much of 1995 stuck in neutral. Hit by slowing car demand and costly new product introductions, Ford's sales rose just 7%, while profits fell 22%, to $4.1 billion. Yet as the greatest bull market in history galloped past its fifth year, investors bid Ford's value up 36% anyway.
It was a remarkable year for Corporate America. The BUSINESS WEEK 1000, which ranks the largest public companies by their market value as of Feb. 29, climbed 35%, an all-time record. With inflation low, interest rates in check, and productivity high, Wall Street suspended disbelief as one company after another churned out strong, steady earnings. Despite a slowing economy, profits overall grew 15% on a 12% revenue hike. Add to that investors' willingness to reward virtually any move--from spin-offs to mergers to stock buybacks--and 1995 was a cakewalk.
But as the savage market fluctuations of early March showed, 1996 is shaping up more like a walk on the wild side. With the economy sending increasingly conflicting signals, such volatility will remain a big feature of the landscape. And that's making a repeat of last year's across-the-board gains look less likely by the day. Although a huge inflow of retirement money continues to backstop the market, skittish investors are becoming more discriminating. "This period really will separate the grownups from the kids," says Dwight L. Gertz, a vice-president of New York-based Mercer Management Consulting Inc.
FALSE TIDE? For the 12 months ending Feb. 29, however, almost everyone enjoyed a playday. Strong fundamentals had a big role: Corporate America continued to reap the benefits of earlier restructuring, as constant attention to costs left many in far better fighting shape than ever before. And with inflation at just 2.7%, short-term rates were cut from 6% in early 1995 to 5.25% in January. The result: Companies churned out high-powered earnings even as the economy slipped into lower gear. And the ebbing of inflation fears left investors willing to pay more for a dollar of earnings than they once were. "What 1995 said--when we marked stock values up--was that we've won the war against inflation," says David G. Shulman, chief equity strategist at Salomon Brothers.
But supply and demand also had a lot to do with the market's rise. As millions of baby boomers plan for retirement, individual investors are throwing oceans of dollars into equities. Last year, $128.2 billion flooded into stock mutual funds alone. At the same time, mergers and share buybacks are eliminating record levels of equity. Even the initial-public-offering market couldn't make up the difference. According to Securities Data Co., companies planned to retire $3.23 of stock for every $1 of new stock issued in 1995; for the first two months of 1996, the ratio hit $6-to-$1. So more money is chasing less stock. "You've got this huge river of money running to the market, no matter what's happening to the economy," says Randell E. Moore, executive editor of Blue Chip Economic Indicators, a newsletter in Alexandria, Va.
In many cases, the resulting stock gains seemed extraordinarily lavish. Philip Morris Cos., for example, saw its 16% profit rise, to $5.5 billion, rewarded with a 60% leap in market value, to $83 billion. Companies practically had to lose their shirts in order to lose market value. Or they had to be once infallible corporate deities that suddenly revealed themselves as merely mortal--as in the cases of Wal-Mart Stores Inc. and Motorola Inc. These were the only two market-value losers among the top 50.
One measure of how easy investors were to please: To get a 1% gain in market value over the past 12 months, companies had to boost profits a mere 0.43%. That contrasted sharply with the prior year, when profits had to grow 6.8% to win the same uptick.
The question now: Where do we go from here? For much of last year, the U.S. economy was clearly slowing. Gross domestic product grew just 1.4% in 1995--the slowest rate in five years--and this year growth should be a sluggish 1.9%. Pricing remains stagnant, and nonfarm productivity fell 0.5% in 1995's fourth quarter. Consumer spending also dropped in January for the first time since 1992. Meanwhile, capital-spending growth should slow to under 5% from 9.9% in 1995, says Allen L. Sinai, chief economist at Lehman Brothers Inc.
Still, some surprisingly strong signs of recent vigor have roiled the markets. After months of anemic growth, same-store retail sales rose 5% in February. And after strong employment numbers came out on Mar. 8, Wall Street, fearful that interest-rate cuts were coming to an end, sent the Dow Jones Industrial Average tumbling 3%. But mutual-fund investors didn't stampede, and much of the drop was recovered in the days that followed.
With Wall Street unsure of where it wants to go, the only thing corporate onlookers agree on is that 1995's market gains won't be easily duplicated. Last year was "an incredible period," says Sanford I. Weill, CEO of insurance giant Travelers Inc. Fueled by its planned $4 billion acquisition of Aetna's property and casualty unit, Travelers' market value ran up 72%, to $21.1 billion. "We all know this won't go on forever," he says.
Weill has a point. For one thing, many of the productivity gains brought by cost-cutting are starting to level off. And with layoffs becoming less politically palatable, companies could face increasing pressure to hold off on further downsizing. Also, while many companies count on export growth to bolster them as the U.S. slows, the economies of Japan, Mexico, and Europe remain weak.
NO MERCY. Given the confusion, it's hardly surprising investors have itchy trigger fingers. In a market this jittery, companies that stumble are quickly left in the dust. The newly discriminating market has one dictum: Shoot the stragglers.
A case in point is once revered Motorola, whose stock plunged 19% on the January day it announced that fourth-quarter earnings would drop 16% after 16 straight quarterly gains. Although Motorola's 1995 profits rose a respectable 14% and CEO Gary L. Tooker insists that "opportunities have probably never been better," it wasn't enough. With sales growth of cellular phones and semiconductors slowing, investors hung up. Motorola's market value fell 5%, to $32.1 billion.
The message: Unlike last year, companies won't get any slack from the market. "Last year was a no-brainer," says Sinai. "This year it's tougher; it's not a dart-throwing game."
Investors increasingly are concentrating on companies that have proven they can withstand a downturn. Classic cyclicals, such as steel, paper, and forest products, were among the few to see market value fall last year, while money continues to pour into those companies with a strong record of churning out earnings gains. From traditionally "defensive" consumer or technology stocks to well-run industrial giants, investors continue to pay for performance.
That's clearly the case with General Electric Co., which retained its No.1 spot as America's most valuable company. With its market capitalization up 35%, to $125.8 billion--a phenomenal $32 billion rise--GE also boasted the biggest overall dollar gain in market value. Although profits were up only 11%, to $6.6 billion on a 17% sales rise, investors are betting on CEO John F. Welch Jr.'s ability to serve up steady double-digit gains. And with 38% of revenues now coming from financial services and 38% from overseas, GE is no longer as cyclically sensitive as it once was.
Technology is another sector that has so far been treated as if it's immune to the business cycle. Last year's Internet explosion fueled the continued spread of computer equipment throughout homes and offices. So even though many tech stocks have sagged from their autumn highs, the computer software and services sector was last year's biggest market-value gainer. Computer hardware makers were hot, too. IBM soared thanks to high demand for--surprise!--mainframe computers, which are enjoying a resurgence in computer networks. With profits up 38%, to $4.2 billion, on a 12% sales gain, IBM's market value rose 55%, to $68.5 billion. And because of strong sales of PCs, printers, and powerful servers, Hewlett-Packard Co.'s profits rose 43%, to $2.6 billion, with sales up 26%. That sent HP's market value up 75%, to $51.4 billion.
Still, that was nothing compared with Sun Microsystems Inc. Its leadership of the high-end market for servers and engineering workstations boosted earnings 75%, to $447 million, on sales up 20%, to $6.4 billion. With 40% profit growth expected in 1996 and its Java software the language of choice for Net-based programming, Sun's market value rocketed 216%, to $9.6 billion. Says Chief Financial Officer Michael E. Lehman: "It's still very hard to find other markets that have as attractive a long-term outlook."
Elsewhere, though, there are warning signs that tech's growth is slowing. Recent profit disappointments from Intel and price cuts from Compaq Computer Corp. have created fears that the sector could harbor "cyclicals hiding in growth clothing," as Richard Bernstein, head of quantitative research at Merrill Lynch & Co., sees it. Demand for PCs is slowing, and a slew of chip factories under construction could bring a glut. Intel is projecting first-quarter sales even with its sluggish fourth quarter, the first time that's happened in seven years. As a result, although Intel's market value is up 47%, to $48.3 billion, that's down 30% from its 1995 high.
There were no such signs of worry in the drug industry, another top performer. As fears of health-care reform faded, players such as Johnson & Johnson and Pfizer Inc. won healthy runups in market value. Wall Street realized that the move to managed care hasn't irreparably harmed profit margins--and that drugs will still be needed in a slowdown. The biggest winner was Merck, which saw its market value rise 54%, to $81.6 million. Continued high spending on research allowed it to introduce a record six new drugs last year. "Investors see that Merck is at the beginning of a cycle of exciting new-product introductions," says CEO Raymond V. Gilmartin.
ENTRENCHED PRICES. Price increases helped, too: Wholesale prices for brand-name drugs rose about 3.3% last year, according to tracking service IMS America. But few other industries enjoyed that luxury. At Gillette Co., consumers--and increasingly, big retailers--are resisting price hikes. Although the company has seen no signs of a slowdown, "we're definitely more cautious about price increases today," says CFO Thomas F. Skelly. Instead, Gillette keeps momentum up with a steady stream of higher-margin new products for U.S. buyers while extending the life of older goods in fast-growing foreign markets such as Eastern Europe and Asia. Today, Gillette launches 20 new products annually--double the rate five years ago--and 70% of its sales come from abroad. That's why profits rose 18%, to $824 million, on a 12% sales gain, winning Gillette a 38% hike in value.
At McDonald's Corp., too, the answer to slow U.S. growth and sluggish pricing has been to boost its 42% share of the hamburger fast-food market. The company opened 1,130 U.S. restaurants in 1995, up from 188 in 1991, and plans another 1,000-plus by 1997. It's pushing into new territory, sharing buildings with new Wal-Mart stores and Amoco gas stations, for example. "If we don't build the restaurant, somebody else will," says McDonald's Vice-Chairman Jack M. Greenburg. And by sticking to a few standard designs, McDonald's has cut construction costs by about 50% since 1990. Such frugality helped it turn in high double-digit growth in sales and earnings--and sent market value up 52%, to $35 billion.
But for many others, the slower economy in 1996 will make life far tougher. With demand flattening and rebates on the rise, auto makers face a rugged year. To avoid the drubbing they took during the 1991 downturn--and to insure that research and development won't be sacrificed when sales dry up--they're continuing to ratchet down spending and hoard cash. That's why Chrysler Chairman and CEO Robert J. Eaton fought so hard against raider Kirk Kerkorian to hang on to his company's $7.5 billion cash pile. Chrysler needs to spend $22 billion by 2000 developing new models.
TRIAL BY FIRE. At Ford, the biggest challenge is slashing global product-development costs. Although Ford's fixed costs have already fallen sharply, its sky-high design and development costs have pushed up new-car prices. So over the next five years, Chairman Alexander J. Trotman aims to trim development costs by $11 billion. He's ending the pricey practice of designing entirely distinct cars for the U.S. and Europe, and he's consolidating global suppliers. But with Ford's margins suffering, will the cuts come soon enough? Although its market value rose 36%, Ford's stock has been treading water since July. "What our critics are looking for," says Trotman, "is evidence we can go through a downturn."
It's not just Ford. Throughout the economy, shareholders continued the pressure to root out hidden costs. Wal-Mart, unable to maintain its once torrid growth, is squeezing pennies. Although store remodeling continues apace, Wal-Mart no longer replaces all floor and ceiling tiles or the phone and security systems, cutting its remodeling costs by about two-thirds and freeing up cash to remodel more stores. Also, with a 43% share of the U.S discount-store market, Wal-Mart hopes to increase sales abroad. It's putting down stakes in Asia, Canada, and Mexico, among others, in hopes of jump-starting growth. But the moves have yet to pay off: It earned just $2.7 billion, a 2% gain, on sales up 13%, to $93.6 billion. That dropped its market value 11%, or $5.8 billion, to $48.7 billion--the biggest fall among all U.S. companies.
If Wal-Mart's efforts to grow got a raspberry from investors, companies that consolidated won their applause. Mergers and acquisitions hit record levels as companies frantically married in search of scale--then looked for fat to cut.
Nowhere has that been more true than in the merger of Lockheed Corp. and Martin Marietta Corp., which formed the biggest player by far to emerge from the defense industry's consolidation wave. Barely 10 months after closing their merger in March, 1995, the two announced plans to swallow most of electronics specialist Loral Corp. as well. The moves will assure the new $30 billion behemoth a far larger share of the shrinking defense pie--and fast and furious cuts. Even without Loral, Lockheed Martin figures it can pare $6 billion in costs by the year 2000; by the end of this year alone, 12,000 jobs will be gone. Vice-President John E. Montague figures combined buying power should help squeeze savings from the $15 billion spent annually. "If you can cut prices by 5%, that's 750 million bucks right there," he says.
Much of the financial-services sector is also counting on mergers to keep earnings moving forward. Such giants as First Union and First Fidelity, Wells Fargo and First Interstate Bancorp, and Chase Manhattan and Chemical Bank joined, creating banks with vast geographic reach--and lots of layoffs. To make their deals pay off, Wells Fargo, Chemical, and Chase need to shut branches and combine operations. But with little overlap at First Union Corp., Vice-Chairman John R. Georgius expects few layoffs; the biggest gains should come from ramping up First Fidelity's fee-based income--now just 25% of revenues--to the 35% garnered by First Union.
Not all banks had to merge to be appreciated by shareholders. At BankAmerica Corp., CEO David A. Coulter has no plans to jump into the fray. Skeptical of mergers, he's more worried that technology and growing inroads by nonbanks are making the competitive environment murky. Instead, plans to buy back $3 billion in the bank's stock have helped send market value up 47%, to $26 billion. Cross-country rival Citicorp, too, figured the best place to put its money was the stock market. In January, Citicorp lifted its stock buyback program by $1.5 billion over the next two years, for a total of $4.5 billion. That, together with signs that Citicorp's five-year turnaround efforts are finally taking hold, sent its value up a stunning 87%, to $33.3 billion.
FOREIGN ADVENTURE. Others not only shunned the merger game, but also split themselves up. Spin-offs provided a surprising number of newcomers to the BUSINESS WEEK 1000 list (page 98). The year's biggest breakup, of course, was AT&T's planned three-way split. That move played a big role in propelling AT&T's value up 25%, to $101.2 billion.
Meanwhile, though, investors continued to back those few conglomerates that have proved they work. One such stalwart is AlliedSignal Inc. Its CEO, Lawrence A. Bossidy, intends to keep it a conglomerate of 15 industrial businesses. "When the economy's up, the pure plays are of more interest," Bossidy says. "When the economy slows, diversity is of more interest." Still, Allied's lines are constantly winnowed: Witness the recent $1.5 billion sale of Allied's small, marginally profitable automobile brake businesses. The proceeds will be invested where returns are stronger. After four years of solid earnings growth, the market bid Allied's value up 47%, to $15.7 billion.
Some BUSINESS WEEK 1000 leaders, such as Coca-Cola Co., are a lot less dependent on the U.S. economy. Coke now gets about 80% of its operating income from overseas. "The labels `international' and `domestic' no longer apply to Coke," says Chairman Roberto C. Goizueta. Also looking abroad is Toys `R' Us Inc. One of the biggest losers for the second year in a row, its market value fell 16%, to $6.5 billion. The retailer has been unable to halt its sliding U.S. market share, as everyone from Wal-Mart to Disney has horned in on its turf. It now counts on expanding in foreign markets "where there is no dominant toy or juvenile retailer," says Gregory R. Staley, president of the company's international division. That will help, but it's not a panacea: The foreign operations of Toys `R' Us aren't as profitable. Look for another tough year here.
And elsewhere. Across the U.S. economy, companies will be facing a less-forgiving investor. As the market continues to mercilessly separate the grown-ups from the kids, those with growing pains won't be treated very gently.By Jennifer Reingold in New York, with Joseph Weber in Philadelphia, Robert D. Hof in San Francisco, and bureau reportsReturn to top