We based our ranking system on two vital financial measures
To identify the companies on the BW 50, we first focused on two core financial measures: average return on capital and growth, both taken over the previous 36 months. For our measure of profits for nonfinancial companies, we used earnings before interest and taxes. The earnings measure excludes distortions from special and nonoperating items as defined by our data provider, Standard & Poor's (MHP) Compustat. We then put these profit numbers into context by figuring them as a percentage of the value of invested capital, basically long-term debt and shareholder equity. For financial companies, we calculated return on shareholder equity using pretax profits as our earnings measure, the better to align our figures with the nature of the finance sector. For our measure of growth for nonfinancial companies, we used sales growth, including gains from operations and from mergers and acquisitions, as reported by Compustat. Growth for financial companies was measured by asset growth.
Next, we compared companies with others in their sectors. (The companies in the Standard & Poor's 500-stock index are divided into 10 sectors.) This enabled us to identify companies that are the best performers relative to their peers, even if their sector of the economy is not booming. It prevents the situation, for example, in which oil companies rise to the top of the list when oil prices are rising and then drop off the list when oil prices are falling.
We started with nearly all the companies in the S&P 500. Then we dropped certain ones from the running because they had become public too recently or had ongoing accounting issues or insufficient data. The McGraw-Hill Companies, BusinessWeek's parent, was omitted as well to avoid any appearance of favoritism.
Within each sector we ranked companies separately by our two measures, return on capital and growth. Then we combined these two numerical rankings, giving substantially greater weight to return on capital, to create a new ranking. The top company in each sector, according to the combined ranking, was given a 1, and the bottom company received a 0, with all the intermediate companies receiving a score according to their ranking. For example, Coach (COH) finished first in return on capital in the consumer discretionary sector and fourth in sales growth, which ended up making it the top performer among its peers.
A list was then constructed of all the companies we analyzed, according to their scores. We applied a tiebreaker—involving comparing our key financial metrics across sectors—where necessary. Finally, this list was reviewed by a panel of editors, applying the one lesson we learned from 11 years of compiling the BW 50: Financial measures applied mechanically sometimes miss the mark. The panel made a small number of adjustments in the ranking.
Our procedure does have some quirks. A company such as electric utility Exelon (EXC) may rank ahead of a tech company with higher return on capital and sales growth, such as Google (GOOG). That's the result of focusing comparisons within sectors, which over the long run produces a more reliable list of the best performers.
Back to the 2008 BusinessWeek 50