The Greatest Companies You Can Own

Milton Friedman once famously wrote that "the social responsibility of business is to increase its profits." He rejected the idea that companies had a responsibility to anything other than the bottom line -- and he wasn't alone.

But recent events in the financial markets have cast serious doubt on his assumption that every company can and should operate as though they alone existed. The subprime, liquidity, and consumer confidence crises demonstrate that capitalism depends not just on maximizing company profits -- but on a systemic concern for the whole.

And there are a number of entrepreneurs demonstrating that taking their responsibility toward others seriously actually contributes to the bottom line -- and shareholder profits.

Everybody wins
Consider the case of socially responsible grocer Whole Foods (NASDAQ:WFMI). When John Mackey co-founded the company (then known as Safer Way) in 1980, it had $45,000 in capital and made $250,000 in annual sales. Since then, sales have expanded to nearly $8 billion, and its market capitalization -- even after losing 80% over the past year -- sits around $1.4 billion.

That's an annualized growth rate of nearly 45%.

How did he do it? As Mackey revealed during a debate with Milton Friedman and Cypress Semiconductor founder T.J. Rodgers, "we measure our success by how much value we can create for all six of out most important stakeholders: customers, team members (employees), investors, vendors, communities, and the environment."

But Whole Foods' commitment to all of its stakeholders hasn't undermined its ability to generate profits. In fact, commitment to its stakeholders allows it to treat customers with "greater interest, passion, and empathy," empower employees, and contribute to communities philanthropically -- in addition to generating profits. The upshot of this goodwill is a healthier and, ultimately, more profitable business.

Mackey considers his stakeholder-centric model and the goodwill it generates to be Whole Foods' most significant competitive advantage and the reason for its success.

Another sign of greatness
And Mackey isn't alone. Jack Welch, who presided over General Electric's 24-year rise from a $14 billion to a $410 billion company, explains in his Lessons for Success, "The three most important things you need to measure in business are customer satisfaction, employee satisfaction, and cash flow."

Why should employee satisfaction matter to shareholders? A Harvard Business Review study found that customer satisfaction -- which, after all, drives revenue -- depends mostly on employee satisfaction.

In other words, if you're looking for a great, profit-generating company, one thing you might look at is how that company treats its employees.

Need more proof? I compiled data from Fortune Magazine's 2002 rankings of "The Best 100 Companies to Work For" to see if great employers also made great investments. Take a look at these returns:

Source: Fortune Magazine and Yahoo! Finance.

On average, publicly traded members of Fortune's "Best Companies to Work For" returned 106% over the next five years, far better than the S&P's 80% gain.

SPICE-y returns
The same thing holds true when we look at companies that are rated excellent at serving all of their stakeholders, what marketing scholars Sisodia, Wolfe, and Sheth called "firms of endearment."

They surveyed thousands of people about which companies they love. Over two years, teams of MBA students visited with the stakeholders of those companies most frequently named, and those visits generated a list of 30 companies, including eBay (NASDAQ:EBAY) and Southwest Airlines (NYSE:LUV), which attract affection and loyalty by aligning with and serving the interests of "society, partners, investors, customers, and employees," also collectively referred to by the interestingly appropriate acronym "SPICE."

The results were astounding: Over the 10-year period ending June 2006, the publicly traded firms of endearment returned 1,026%, more than eight times the S&P 500's 122% gain. They also crushed the market over five- and three-year periods.

Put them to work for you
John Mackey argues that "these ideas will triumph over time, not by persuading intellectuals and economists through argument but by winning the competitive test of the marketplace." And they've already begun.

Here are a few rules of thumb for profiting from this trend.

• Put the companies you love on your research list -- and find out if others share your love.
• Look at lists of the best companies to work for as well as lists of firms of endearment to find companies you might not have heard of.
• Invest in companies whose management is focused on creating enduring businesses through delighting customers and caring for their employees.

Fool co-founders David and Tom Gardner have recommended to Motley Fool Stock Advisor members three stocks that are both firms of endearment and members of this year's list of the best companies to work for. Tom and David believe that company engagement, backed by excellent business practices, is a surefire combination. To date, their picks are up 13% on average, versus a 17% loss for like amounts invested in the S&P 500.

Want to find out which three companies made David and Tom's roster? Just click here for a 30-day free trial -- there's no obligation to subscribe, and you'll also see all of their recommendations for new money now.

Ilan Moscovitz owns shares of Whole Foods but of no other security mentioned. eBay and Whole Foods are Stock Advisor recommendations. The Fool has a spicy disclosure policy.