Good Management Pays Dividends

Taking stock of IndustryWeek's 100 Best-Managed Companies.

How much better do the stocks of companies that are considered well-managed -- those whose top and bottom lines are sound, and who invest in innovation as well as their people and communities --do when compared with their industry peers? To what extent do shareholders share in the good times? It's an ongoing question that academicians, consultants, and many other experts have studied. It's also an issue that IndustryWeek was interested in exploring. To do so, we turned to the 1998 IW 100 Best-Managed Companies list published in the August 17, 1998, issue, and calculated shareholder returns for the one- and three-year periods ending Sept. 30, 1998. How did shareholders make out? Very well, judging by the companies' performance during the last three years. The IW Best-Managed Companies achieved an impressive return of 119% -- nearly double the 64% rise in the Dow Jones Industrial Average and the 74% rise in the Standard & Poors 500 for the same time period. A good part of the rise in the IW list of 100 resulted from the phenomenal growth of Dell Computer Corp. The Round Rock, Tex., juggernaut shot up 2,375% in the last three years. Yet, even with Dell excluded from the calculations, the average three-year gain is about 96%. The one-year performance numbers are less heady. Although some companies, particularly those in the pharmaceutical and computer industries, have continued to do well, the average change for the IW Best-Managed Companies was a blip of less than 5%. This compares with a decline of 1% in the Dow Jones Industrial Average and a rise of 7% in the Standard & Poors 500 for the same time period. The disappointing numbers in part reflect the turmoil in the international economy, particularly Asia, says Delos Smith, senior business analyst with The Conference Board, New York. "In these kinds of conditions, when the world has lost a major market, a well-managed company can survive, but the returns won't be as good." Company performance also varied -- somewhat starkly -- by industry group. Computers, again led by Dell, were up 450% over three years. That's more than double the next group of companies, pharmaceuticals, which turned in an increase of 209% for the last three years. Not far behind were computer-software companies, up 191%. The same three groups also have done well during the last year. "High-tech has been the glamour child of the industry. Each company has something: Microsoft, sheer size; Dell, a unique business design; and Cisco, proprietary products," says Joe Martha, a Cleveland-based vice president with Mercer Management Consulting. On the other hand, the average total return for both industrial-equipment and metal companies for the last three years is in the high teens. Year-to-date performance has been even more punishing; metals are down 17%, and industrial equipment is off 25%. When assessing corporate performance, it's critical to compare apples to apples, says Sandra Waddock, professor of management with Boston College's Carroll School of Management. "If the stock market or industry is falling, you have to take that into account. You can't just look at the company." While a company's performance is affected both by the state of the economy and the state of its industry, no one -- least of all executives -- is saying that nothing can be done about it. Chris Zook, manager of the strategy-practice group at Bain & Co., Boston, cites a survey he worked on several years ago. Four thousand executives were asked the reason for a major change up or down in their performance. The executives themselves attributed only about one-fourth of the changes to outside factors, such as an unexpected move by a competitor. Three-quarters said management and its choice and execution of strategy accounted for the change in performance. The IW Best-Managed Companies, on the whole, also excel in more qualitative areas, such as investment in people and communities. Other studies have found the same connection. For example, a study by Waddock and Samuel B. Graves, also of Boston College, examined 469 major companies. The results show a positive correlation between corporate social performance -- in areas such as employee relations, community relations, and performance with respect to the environment -- and financial performance. A report by Michael Halloran, a Dallas-based senior vice president with SCA Consulting, looked at the correlation between shareholder and stakeholder return in five industry groups: chemicals, computers, electronics, food/beverage, and pharmaceuticals. Halloran measured total shareholder return over the three-year period of December 1993 to December 1996. To judge stakeholder return, he looked at growth in employee population, charitable giving, and several other factors. His results show that in 63% of companies, shareholders and other stakeholders either do well or do poorly together. "There's a pretty strong record that high-performing financial companies are strong in other areas," says Halloran. What's less clear, say the experts, is discerning which is the cause and which is the effect. Do companies decide to adopt a new management practice or invest in their communities when they are doing well and have the resources available? Or is a good track record in these areas somehow inextricably tied to other aspects of management? Further, how much of an impact does a firm's reputation as a well-managed company have on its share price? And, in this age of political correctness, how much is reputation driven by a firm's social, as well as its financial, performance? The answers are far from clear, says Edward E. Lawler III, professor of management at the University of Southern California. He says his work has shown that all factors -- a company's performance, its reputation, and its willingness to adopt best management practices -- are linked. Even if it is difficult to come up with clear cause-and-effect relationships, there are some insights management can draw from the performance of the IndustryWeek 100 and the other analyses discussed here. Aim to lead, even if your industry isn't a leading one. "There are plenty of companies in mediocre industries that have earned great returns," says Bain & Co.'s Zook. SCA Consulting's Halloran agrees. He points out that because investors want to diversify, they'll look at the top one, two, or three companies in an industry, even if the industry overall is underperforming. Go for broke. "A company's strategy should be to develop wide competitive gaps against their competitors, to a point where they can outperform them by the widest possible margin. Being as good as, or slightly better than, other firms in your industry isn't good enough," says Zook. Let others know what you're doing. "There's a lot of evidence accumulating that companies that are seen as best-managed, or companies that adopt particular practices, tend to outperform the market," says Lawler. For example, some have argued that because General Electric Co. CEO Jack Welch is such an articulate spokesperson for the company and its management, the company's stock price is about 10% higher than it otherwise would be.


Crunching The Numbers
First, it's essential to acknowledge the financial wizards who helped to make this information possible. Amassing performance data on the stocks of companies that are based all over the world isn't easy. The following people provided a great deal of time, expertise, and guidance in this effort: Jennifer Isola from Baseline Financial Services; Don Parker and Meredith Lawrence from Bridge Information Systems Inc.; Jake Matyas and Art Harmon from Thompson Investor Relations Strategic Consulting Group; Severo Nieves from Value Line; and Chris Southern and Lawrence Sterne from Wall Street Research Net. With the exception of Thompson Investor Relations, which is in Chicago, the companies are located in New York. Here's what the numbers mean and how we arrived at them: The numbers represent the total return earned by the stocks for the three-year period ending Sept. 30, 1998. This means that they account for the rise in the price of the stock, adjusted for any stock splits or dividends, and assume all dividends are reinvested. In a couple of cases, the numbers provided cover slightly different time frames; these are noted on the charts. Calculating the return on companies that are based outside the U.S. can get a bit difficult. Where possible, we looked at the performance of the company's ADR, or American Depository Receipt. ADRs allow U.S. investors to own securities of non-U.S. companies, similar to the way in which they hold securities of U.S.-based companies. The performance of an ADR should closely track the performance of the stock itself. There were a handful of companies that did not trade in the U.S., as either a stock or an ADR. In that case, we went to the companies themselves and looked at how they did over the time period on the exchange(s) they did trade on. Once we had the return figures for each company, we calculated the average total return across all 100 companies and compared it with the performance of the Dow Jones Industrial Average and the Standard & Poors 500 for the same time period. Then, in addition to our own review of the numbers, we asked experts from business and academia for their thoughts on the results.
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