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What does it take to build a thriving business in today's tough economy? The same qualities that have always been required: a willingness to take risks, a business plan that holds up in bad times as well as good, a strong vision, and of course, a big helping of luck. Our annual Hot Growth ranking of America's fastest-growing small companies shows that those qualities are as plentiful as ever.
Just look at Ronald M. Shaich. He co-founded Au Bon Pain, a chain of caf?s, in 1981. But with the purchase of another little chain called Saint Louis Bread Co. in 1993, Shaich thought he could do even better. What struck him: Saint Louis Bread, like Starbucks Corp. in coffee or some of the specialty brewers in beer, seemed to satisfy consumers' desires for high-quality, unique products. "Customers are rejecting fast food. They want something better, something special," Shaich says. Before long, he made a big bet: He sold off the Au Bon Pain operations in 1999 to a private investment group, renamed his company Panera Bread Co., and focused on expanding the chain of bakery-caf?s.
Shaich may just be on to something. Although the stock is off 6.4% since Jan. 1, to about $33, Panera is ringing up impressive numbers. Over the past three years, sales have climbed at an average annual rate of 19%, to $277.8 million last year, while profits climbed a heady 78% annually, to $21.8 million. Adams, Harkness & Hill Inc. analyst Scott Van Winkle says Panera, No. 52 on this year's Hot Growth list, has thrived in this tough economy by offering high-quality dining at fast-food prices: The average tab is under $7.
That ability to turn today's grueling business environment into an advantage characterizes many of the 2003 Hot Growth companies. Companies that offer their customers a better deal or a way to cope in a weak economic environment also have the edge. Steven D. Fredrickson, co-founder and CEO of Portfolio Recovery Associates Inc., certainly found his company in the sweet spot this year. That's because the Norfolk (Va.) company is the financial industry's equivalent of a scrap-metal dealer. After big credit-card issuers exhaust all efforts to collect on their most delinquent accounts, Portfolio Recovery swoops in and buys up the debt, often for only 2 cents to 3 cents on the dollar. Its collection agents then hit the phones, wheedling whatever they can from the deadbeats.
It doesn't have to be a lot. "We define [it as a] success if we can collect 6 cents on the dollar," says Fredrickson. Those pennies are adding up for investors: The stock has jumped 60% just since the beginning of 2003, closing recently around $30. And over the past three years, revenues have soared an average 67% annually, to $62.6 million, while profits have risen an average 113%, to $18 million. Performance like that helped Portfolio Recovery land the No. 17 spot in this year's Hot Growth ranking.
To find the companies that have a winning formula, BusinessWeek casts a wide net, looking at publicly held companies with revenues as low as $50 million and as high as $1.5 billion. Then we rank them based on sales and earnings growth as well as return on capital over a three-year period, to identify those hot performers that have some staying power. Each contender must have a market cap of at least $25 million, and its stock price must be at least $5 per share. We also eliminate companies with recent earnings declines or ones whose stock has underperformed the Standard & Poor's Industrial Composite Index. The top survivors make the Hot Growth 100.
As a group, our companies churned out average annual sales growth of 25.5% and average earnings growth of 44.4% over the past three years. Compare that with average sales growth of just 5.8% and a 24% drop in profits for the S&P industrials over the same period. The average return on capital for the Hot Growth 100 was just as impressive -- 14.9%, vs. 5.25% for the S&P industrials.
So what industries were big this year? Six education companies made the grade, with more workers trying to polish their r?sum?s and upgrade skills in a tough labor market. Companies like No. 7 Apollo Group, No. 19 Career Education, and No. 25 Strayer Education cater to adults in search of better-paying jobs. "There is now an 85% to 90% income differential between those who have a college degree and those who don't," says Greg Cappelli, an analyst at Credit Suisse First Boston. "Yet 70 million working adults don't have a degree." And with the nation's traditional nonprofit universities raising tuition far above the inflation rate, it leaves plenty of room for these profit-making schools to boost prices.
Twenty-seven companies on this year's list are in the health-care industry. Many of them thrive by reducing costs of care, a strong selling point at a time when those costs keep rising. Odyssey HealthCare Inc., No. 3 on our list, provides hospice care to terminally ill patients -- a less costly and often more humane alternative to hospitals. And players like No. 15 Sicor, No. 22 Eon Labs, and No. 41 Mylan Laboratories are cashing in on the need to reduce health-care costs by supplying generic drugs -- cheaper versions of brand-name products. "Everyone is complaining about the cost of drugs," says Sicor Inc. CEO Marvin S. Samson. "We are in the right place at the right time."
Other health-care competitors are exploiting new technology before the heavy competition moves in. Biosite Inc., No. 47, has posted average annual profit growth of 113% over the past three years, thanks to its pioneering blood test for congestive heart failure. Meanwhile, No. 20 Varian Medical Systems Inc. sells systems for delivering targeted doses of radiation for cancer treatment. While the core technology to do this has been around for years, Varian created automated systems that make the therapy more precise. And Varian is already busy developing next-generation equipment so exacting that it can target a tumor even if its location shifts during a treatment session. Says CEO Richard M. Levy: "You can't stop developing in this kind of business."
Retailers always have a big presence on the Hot Growth list. In an environment that remains brutal for many department stores and big-box chains, our 19 pint-size sellers have distinguished themselves by carving out niches that can withstand a down economy. Our top Hot Growth Company, Aeropostale, is a teen retailer that sells value-priced apparel similar to the wares of higher-priced competitors like American Eagle Outfitters. No. 2 Chico's FAS Inc., which is making its fifth appearance on the list, has generated average annual sales growth of 50% over the past three years. Credit the chain's ability to sell stylish casual clothes that appeal to baby boomer women.
No. 6 Hot Topic Inc., a marketer of edgy teen fashion, stays in the game by catering to the adolescent appetite for the latest pop music styles. No. 12 Coach Inc. has a much older base of customers, but it managed to lure in a new generation of upscale buyers by revamping its staid image with fresh designs and carefully planned brand extensions. "[These retailers] have brands that are very consistent, and they know their niche really well," says Cynthia R. Cohen, president of retail consultant Strategic Mindshare.
Even among tech companies, which as a group remain mired in a slump, a select few have found a way to grow through innovation. Cognizant Technology Solutions Corp., No. 8 on the Hot Growth list, is prospering with products like the Web-based customer service site it set up for General Motors Corp. car owners in 2001. The site allows users access to information on topics such as warranties and service histories. The company keeps costs low by using just a handful of managers in Detroit and some 25 software developers in Bangalore, India. "We allow companies to substantially cut their costs and transform their systems to work better," says Kumar Mahadeva, Cognizant chairman and CEO.
Of course, technology that makes customers happy is always a winner. Internet survivor eBay Inc., No. 43, continues to grow by expanding the variety of products its merchants offer while simplifying the payment process. Last year it bought payment processor PayPal Inc., which allows buyers to pay eBay's merchants online.
Sometimes a company simply reinvents itself, building on a well-known brand to enter new markets. Take WD-40 Co. When Garry O. Ridge took over as CEO in 1997, he didn't want to be just a caretaker of the company's core product, a 50-year-old lubricant. So he made a series of acquisitions, adding products like 3-In-One drip oil and 2000 Flushes toilet bowl cleaner. They may not be sexy, but they've helped generate a 20% return on capital -- and earn the No. 46 spot in Hot Growth. "You need to have a great product, make the end user aware of it, and make it easy to buy," says Ridge.
Sounds simple. But the ability to execute is what makes these small players stand out. "Darwin said it is not the strongest or fastest that survive but those that can adapt quickly," says O. Thomas Barry III, chief investment officer at Bjurman, Barry & Associates and the manager of a small-cap fund there. In a sagging economy, that's a trait many bigger rivals surely envy. By Amy Barrett in Philadelphia, with Dean Foust in Atlanta and bureau reports