Fortune Magazine released its latest annual 100 Fastest Growing Companies list in the September 6, 2004 issue. At the top, for the second year running, is airport X-ray machine maker InVision Technologies
While I do not consider this list to be a blind directive of what companies to own (more on this in a moment), it is probably a good starting point for further investigation.
To be considered, a company must be a U.S. firm with at least a $50 million market cap. It must have had at least $50 million in revenue over the past four quarters and at least a 20% annual growth rate in both sales and earnings per share over the past three years. Companies that were real estate investment trusts (REITs) for the entire three-year period were excluded. The final list is ranked according to earnings per share, revenue growth and total return. The figures for annualized revenue growth ranged from InVision's searing 93% to Hilb Rogal & Hobbs'
The trouble is, this list is backward looking, and investors are not. The past might be a decent predictor of the future within a category like "most stable dividend payers," but among the fastest growth companies, it's tough to remain king of the hill -- or even on the hill -- for long.
Of this year's 100 companies, only one, Forest Laboratories
Look at it this way. If, five years ago, you'd invested equally in the 24 of this year's top 25 companies that were around back then, you'd have earned 612%, or 48% per year.
Phenomenal, of course, but the whole point is that you wouldn't have had this year's list available. In the height of the tech bubble, who'd have guessed that Central European Distribution Corp.
As an investor, I am not so much interested in what companies have grown the fastest over the last three years. I want those companies that are going to grow the fastest over next three years... or four years, or five years... or even one year. And for that, I need foresight. But just how much does Fortune's list give me?
Let's look at the 1999 list. If you'd bought equal dollar amounts of the top 25 companies, you'd have made an unspectacular 7.9% per year. (Returns do not include three companies that have been purchased or merged; also, none of the calculations in this article include any consideration for dividends, if any.) These returns do include Meritage Corp.
All right, I can hear the objections now. Maybe that wasn't a fair test. The fall of 1999 was near the peak of the tech bubble, and those companies had been picked based on growth rates that could never last.
Let's look instead at last year's list. Again not including the three companies that have been taken over since then, an equal dollar investment in the top 25 of 2003 would have returned 12% -- better than the S&P 500's 9% -- over the last year. That includes seven companies that have dropped at least 20% and nine companies up by at least the same percentage. I don't know about you, but a 12% return is the minimum of what I want when I pick my own companies rather than invest in an index fund, especially if I'm picking risky growth companies. In other words, I'm not impressed.
If we back up a year to the 2002 list, the return of the 24 surviving companies out of the top 25 would have yielded 49%, or 21% annually. Ah, that's better. However, eight of those companies are oil and energy companies. And with the upcoming Iraq war looming large in investors' minds, it's not unreasonable to assume that many investors wouldn't have wanted to gamble on any companies exposed to such unpredictability. An investor choosing to avoid those eight companies would have received only 13%, or 6.3% annually.
So what is an investor to do? Is the Fortune 100 Fastest Growing Companies list nothing more than a list of companies doomed to fail to live up to expectations? Can nothing be salvaged? Well, rather than get caught up in the hype of seeing who has performed the best, it might be better to use this list as a simple starting point for growth stock ideas.
But that requires work on your part. Dig into those companies' annual and quarterly reports. Ignore the sexiness of being listed and try to figure out what each company's prospects might be going forward. If you're into valuations, try to see what sort of growth rates these companies will need to sustain their current prices. In other words, rather than treating this year's list as a list of "must buy" companies, treat it as a starting place for further research. After all, you might find the next Starbucks
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Jim Mueller likes to make lists of what is needed from the grocery store. None of the companies listed (there's that word again) is in his current holdings. He welcomes your comments . The Fool has a disclosure policy .