Charting the CEO 100 Index
How to Build and Protect Shareholder Value
For the first time in three years, investors who bet on a basket of top stock-market performers suffered a setback. In our fourth annual glimpse at the CEO 100 index, the CEOs of these companies describe how to build and protect shareholder value.
In 1992, we began to track the performance of the CEO 100--a set of companies that posted superior stock-price gains over a three-year period with a single CEO in place--and compare it with that of the benchmark S&P 500 Composite Index. Our premise was that stock-price performance is driven in part by talented chief executives, and that companies run by such CEOs--as an aggregate--represent a sound investment opportunity.
Despite a minor setback in the last year, the value of the CEO 100 as an investment discipline remains intact.
Meanwhile, in 1994 we broadened our scope, initiating a dialogue with CEOs on strategies to increase stock price and shareholder value. This year, in our fourth annual look at the CEO 100, we continue that dialogue, and begin to experiment with narrower, more specialized statistical tools to rate corporate performance and isolate the CEO contribution to stock-price movements.
The 42 CEOs who completed our survey describe how they leverage share-price growth to reward shareholders, recruit top talent and customers, and gain a cost-of-capital advantage. Along the way, many CEOs find themselves grappling with the thorny issue of communications--both with the investment community and with primary stakeholder groups. In addition to our annual CEO 100 report, we place three of our top performers under the microscope. The trio comprises Michael J. Birck of Lisle, IL-based Tellabs (673 percent stock-price gain from 1992 to 1994); John G. Adler of Milpitas, CA's Adaptec (440 percent); and James C. Morgan of Applied Materials (379 percent) in Santa Clara, CA.
To make the CEO 100, each CEO had hold that position throughout 1992-1994, the company had to be public for that entire time, and the market value of the firm's public stock had to exceed $500 million at the end of 1994. Value Line again assisted in this research, making its data base of more than 5,000 public companies (primarily U.S. and Canadian) available.
Although we cannot say the CEO 100 will always outperform the S&P 500, the CEO 100 Index continues to provide a superior method of investing over the measurement period. Provided the portfolio is bought the month the list is published in Chief Executive and is sold one year later, on a cumulative basis, the first three lists are up 10.0 percent compared with the S&P 500 at 7.6 percent (see Exhibit I) during the 12 months following publication. This exceeds the track record of more than 80 percent of professionally managed portfolios during this period.
Probably because of the high volatility of these stocks--most of which are small caps--we should expect relative underperformance in years when the overall market is weak, as occurred in 1994. Last year's list actually dropped in value by 7.2 percent, while the S&P 500 declined by only 1.5 percent, measured on a calendar-year basis. The results are positive, however, if measured from the time of the list's publication at the end of June 1994 through the end of the year. From that perspective, the CEO 100 grew by 3.1 percent, while the S&P 500 declined by 0.6 percent. We will continue measuring the current list through June 1995 and report the results next year. Using this "publication year" measurement, the 1990-1992 list dropped by 4.8 percent while the S&P dropped by 1.4 percent.
Nevertheless, as a group, the new CEO 100 expanded its stock price on average by 310 percent over the three years, while the S&P 500 Composite Index rose by only 10 percent. Moreover, 10 CEOs have been on the last three CEO 100 lists. These repeaters are listed in Exhibit II. Certainly, investments in them have paid off handsomely. Their average gain in 1994 was a strong 13.3 percent.
The number of CEOs appearing for at least two consecutive years also increased from 31 a year ago to 37 in the current list. This trend, if continued, will mean an increased value of the list as a source of investment opportunities as well as ideas on managing companies for faster stock-price growth.
Six of these two-year repeaters are among the top 10 on this year's CEO 100. They are headed by James L. Donald of DSC Communications, Plano, TX, (telecommunications equipment) in first place; Terence H. Matthews of Newbridge Networks, Kanata, ON, Canada, (digital communications systems) in third place; Phillip E. White of Informix, Menlo Park, CA, (software) in fifth place; Eric A. Benhamou of 3Com, Santa Clara, CA, (computer networking) in sixth place; Birck from Tellabs (telecommunications equipment) in seventh place; and L. Lowry Mays of Clear Channel Communications, San Antonio, (television and radio broadcasting) in 10th place. Rounding out the top 10 are newcomers Michael C. Ruettgers of EMC, Hopkinton, MA, (computer storage subsystems) in second place; Charles P. Johnson of General Datacomm Industries, Middlebury, CT, (telecommunications and data communications equipment) in fourth place; George Perlegos of Atmel, San Jose, CA, (semiconductors) in eighth place; and Stephen Wiggins of Oxford Health Plans, Darien, CT, (managed health care) in ninth place.
EXHIBIT I - Battling The Benchmark
CEO 100 Performance: Stock-price changes for 12 months following publication of list and for year to date.Cumulative to 12 months following December 31, 1994 CEO 100 S&P 500 CEO 100 YTD S&P YTD 1989-91 List 12.1% 9.8 7.1 9.9 1990-92 List -4.8 -1.4 1.3 1.9 1991-93 List 3.1 -0.6 Ñ Ñ Cumulative 10.0 7.6 NA NA change
Dates of purchase are end of month, published as follows: 1989-1991 list: 9/30/92; 1990-1992 list: 6/30/93; 1991-1993 list: 7/29/94. Cumulative change is through year to date: 12/31/94. Cumulative change numbers combine performance of lists in 12 months following publication, or through 12/31/94 if less than a year has passed. Source: Mitchell and Co.
As some readers have rightly pointed out, our CEO 100 list tends to be dominated by executives from industries where the entire sector did well. Technology companies, for instance, are heavily represented in this year's list.
As a result, we are working to refine a new set of measurements and to develop a benchmark that will more narrowly measure what is or may be the CEO's influence on stock-price fluctuations. One of these new measurements will adjust stock-price growth for the industry in which a company falls. Others will adjust for e.p.s., cash flow, and sales growth, and provide objective measures of per share changes in earnings, cash flow, dividends, sales, book value, and increases in profit and gross margin percentages. After each of these adjustments is made, a final step will adjust for all these factors simultaneously, yielding the most specific measure yet of the CEO factor in stock-price fluctuations.
Although many of the same companies dominate most of these different performance measures, their rankings vary. Interestingly, many grew their earnings much faster than their stock price. and our top performers expanded their P/E multiples and outgrew their industries by a wide margin.
With these insights in mind, our follow-up interviews concentrated on those CEOs whose companies performed well in a variety of measures in addition to those who have persisted in their success from year to year.
For an additional perspective, we plan to interview the CFOs at these companies and compare their perceptions about what drives stock prices with those of their CEOs. The results of that research will be reported in an upcoming issue of Chief Executive.
Last year, we promised to report on the performance of the 31 companies that repeated on the list from the prior year. Results were not positive: Those companies saw their stocks drop by 10.95 percent. We will continue to search for ways to generate even better investment results from the CEO 100 and report the results next year. Ideas we will test include focusing on low-beta stocks, CEOs who have remained on the list for two to four years, and various ways of segmenting the list based on trends near the end of the measurement period.
EXHIBIT II - The Perfect 10 Chief executives who made the CEO 100 three consecutive years (annual position in parenthesis).CEO Company Industry Ranking* Terence H. Matthews Newbridge Networks Digital comm. (70-1-3) Phillip E. White Informix Software (27-2-5) John G. Adler Adaptec Computers (60-24-18) James C. Morgan Applied Materials Semiconductors (99-35-21) Lawrence M. Coss Green Tree Financial Finance (53-20-54) Cal Turner Dollar General Retail (43-28-56) Robert H. Swanson Jr. Linear Technology Semiconductors (25-48-57) B. Thomas Golisano Paychex Payroll (74-82-78) Richard F. Teerlink Harley-Davidson Motorcycles (40-73-85) Louis L. Borick Superior Industries Automotive parts (48-37-95)
Footnote*: (2 years ago-1 year ago-this year) Source: Mitchell and Co.
Lessons In Management
In last year's roundtable, "CEO Strategies To Increase Share Price" (Chief Executive: July/August 1994), CEOs disagreed about the importance of share-price improvement and the role a CEO can play in achieving it. This year's CEO 100 helped clarify those reservations by first ranking the areas where stock-price growth is an important factor, then describing how they help achieve it. All agreed that stock-price growth is important to reward shareholders, and 98 percent saw it as important in attracting and retaining outstanding employees. Continuing down the chart were its value as a source of cost-of-capital advantages over competitors (87 percent), to provide cash for faster growth (80 percent), and as a source of credibility to attract and retain customers (70 percent).
"People like to do business with winners," says David R. Holmes of Reynolds & Reynolds, an information management systems company in Dayton, OH. "Customers want someone who will be there to serve them in the future."
That advantage is particularly important to small companies, says Tellabs' Birck. "We're in a business populated by AT&T, Ericsson (also a CEO 100 company), and Siemens," he notes. "For customers to trust us, they must have confidence in our reliability, and they want to know they are dealing with a stable entity large enough to support their needs. One way to gain their confidence is to successfully show growth, and that often translates into a premium stock price."
EMC's Ruettgers offers his company as an example: "A major set of our products goes to Fortune 500 companies. It's difficult to sell to some because they are so conservative and will work only with well-known companies. Being the top company in terms of stock-price growth and joining the Fortune 500 last year makes other Fortune 500 companies comfortable doing business with us."
But a company's stock growth keeps customers happy indirectly as well, through its employees. "How your employees feel is reflected into your customer," explains John P. Morgridge of Cisco Systems, a supplier of integrated computer networks based in San Jose, CA. "Quality and attitude of employees is fundamental to success. Enthusiasm and belief are very contagious. You want employees who are enthused about the activities they are involved in and the company they are associated with."
As for providing cash to speed growth, consider the experience of Leonard G. Herring of Lowe's Cos. home centers, based in North Wilkesboro, NC. "The improved price of our stock has enabled us to raise funds and issue convertible debentures on an affordable basis. Increasing our equity position has improved our debt/capital ratio," says Herring, who offers the numbers that prove his point. "In the past two-and-a-half to three years, we have raised approximately $600 million -- from a sale of convertible debentures netting $250 million, $316 million in stock, and approximately $32 million through the issuance of new stock for the funding of our ESOP."
"Our corporate strategy is to grow through acquisitions. Lower cost of capital enhances our ability to finance acquisition opportunities that are an important part of our strategy," agrees Paul A. Ormond of Health Care & Retirement in Toledo, OH.
It can be equally important when part of the strategy is to avoid being acquired, counters Oxford Health's Wiggins: "Having the highest P/E in the HMO sector makes my company somewhat more acquisition repellent."
EXHIBIT III - CEO Stewardship
CEO 100 chief executives rank their most critical tasks in achieving stock price growth.Communicating vision and/or strategy 26% Achieving financial targets 15 Communicating with investment community 15 Managing human resources 12
Source: Mitchell and Co.
The CEO's Contribution
Not only are this year's CEO 100 members certain of the value of stock-price growth, they are confident they have contributed to their companies' outstanding performances. While 88 percent describe their own role as contributing a great deal or a significant part to that success, only 12 percent claim to have been a minor influence. Most (26 percent) see their part in this achievement as communicating the vision and/or the strategy of the company, both internally and externally. Another 15 percent say they were instrumental in their companies' achievement of financial targets; 15 percent, in improving or maintaining quality communications with the investment community; and 12 percent, in human resources management (see Exhibit III).
Last year, many CEOs told us they had developed a number of best practices for communicating with the investment community. This year, 42 of the CEO 100 helped us to better understand what those best practices are and why they work.
First, Ray Stata of Analog Devices, a precision electronic components concern in Norwood, MA, defines the territory. "The vision has to do with the strategic plan of the company, what markets we are going into. The values area is a question of how we want people to behave toward each other and customers. The strategic process is one of business planning, in which you lay out your vision and plan. Then, communicate it, which we do mainly through annual reports, annual meetings, and presentations."
It's important to have this firm concept of your business model from the beginning, emphasizes Cisco's Morgridge: "Once you have it, you can communicate it. The model has several components: growth expectations, gross margin, operating expenses, and taxes. From that, you and analysts can construct and understand how you are doing your business. We explain changes and outline what caused changes on a quarterly basis."
Laying this groundwork is critical to helping employees perform at levels that lead to stock-price growth, the CEOs agree. "A CEO alone cannot do a lot about stock price unless there is some underlying performance. To me, that means being involved in corporate strategy and employee activities, and making sure that we treat our people properly," says Tellabs' Birck.
"Many people in my position got there because they were very good individual contributors, and very good at achieving goals themselves," adds Leonard C. Perham of Integrated Device Technology, a semiconductor manufacturer in Santa Clara, CA. "When your job is CEO, your job is to enable others to do the job. Set the stage and provide opportunity. You have to be willing to step aside and be patient in order to give people freedom to solve problems in their own way. A personal challenge for me is being patient. I'm always anxious to see problems solved -- wanting to get a look at the problem so I can better understand the range of solutions. I have to be careful not to interfere, yet encourage the expeditious implementation of the right solution."
The CEOs spend a surprising amount of time communicating with the investment community about their companies, averaging 23 days a year but some spending as many as 90 days. The low is five days per year. Of particular interest is the criteria they use to decide how much time is enough. Some, like Richard F. Teerlink of Harley-Davidson in Milwaukee, set limits. He spends six days a year, noting, "It's appropriate, and that's effective communication. I don't have the responsibility for investor relations, the CFO does. I respond to the needs he and the portfolio managers and analysts raise."
Reynolds & Reynolds' Holmes is closer to the average, devoting 20 days a year to this role. "Strike a balance between the demands of business and accomplishing what we define in the IR/PR program," he advises. "There are certain cities and accounts we want to hit. We are conscious of what is happening to our stock price and how much news we have to tell. We have a comprehensive IR program and provide regular information to keep accounts updated on our performance. We are trying to broaden the ownership of our stock, and, of course, improve the multiple."
But it's a bigger job for George T. Jochum of Mid Atlantic Medical Services in Rockville, MD. He's at the high end of the scale, spending 60 days a year on investor communication, for a specific reason: "In the financial world, we are not very well-known. We are regional, so it is important we get visibility."
While there is a wide range of delegation and time spent, the differences in contact with portfolio managers (who usually make the decision to buy, sell, or hold company shares) are even bigger. The average is 38 days per year, with five the low. Ormond, of Health Care & Retirement, says he met with about 50 portfolio managers last year, including "those who already owned our stock, others who had investment experience in our industry in general, and individuals who expressed interest in HCR specifically."
EMC's Ruettgers meets with more than 100 portfolio managers a year. "It's important," he says, "if you are trying to get a company message out to as many interested parties as possible, particularly shareholders. The benefit is that EMC was ranked No. 1 in the Forbes survey of five-year stock appreciation of 1,300 companies."
Room For Improvement
Still, CEOs aren't satisfied with their performance in this arena. When asked where they most need help to increase stock-price growth, 17 percent cited improved communication skills for dealing with current and potential investors. No other response got more than one answer.
It's a need they see in companies across North America, topping a trio of helpful hints they offer colleagues not yet on the CEO 100 list: Communicate better with investors and analysts, meet or exceed earnings and revenue expectations consistently, and have an excellent corporate strategy.
They describe the factors that affected their stock-price growth over the past three years much as their predecessors did a year ago. The most important elements are fast prior growth, expectations of growth after 1994, improved profitability, management credibility, and outperformance of analyst expectations in the past.
Establishing credibility after problems arise is important to Donald Fites, CEO of Peoria, IL-based construction equipment manufacturer Caterpillar. "I met with them face to face," he says, noting he has been doing this ever since becoming CEO in 1990. "I told them our strengths and weaknesses, and how we would work on the weaknesses. I laid out the general financial targets I was going to use to assess company and business unit performance. Over time, they became more and more convinced we would, in fact, perform on that basis."
Patience for the long term is important. "Management credibility comes with time and performing well over the years. We always perform as expected and to how we project," says Clear Channel's Mays.
"All that is required is being honest," counsels Robert G. Paul of The Allen Group, a telecommunications equipment manufacturer based in Beachwood, OH. "You get judged by being forthcoming, taking the initiative, and quickly communicating negative news or news that could be construed as negative."
Donald N. Boyce of IDEX in Northbrook, IL, also takes the opportunity to set high expectations. "We tell them what our historical performance has been, and our objectives for the future," he says. "We've had 20 percent compound annual rate of growth in net income from market development, new products, international development, and acquisitions. We introduce ourselves, describe strengths, and outline plans for the future."
Be clear about the time elements in your industry. Richard W. Ussery of Total System Services in Columbus, GA, gives an example: "Our company is a growth company, and we are a technology stock. Over 12 years, we have grown earnings and revenues 25 percent a year. Expectations have a lot to do with matching that record going forward."
Gamesmanship figures prominently in the tactics used by Peter McCausland, CEO of Airgas, a distributor of industrial, medical, and specialty gases based in Radnor, PA. He recommends that other CEOs use the same ploy to consistently outperform analysts' expectations by underpromising results in the first place. How does he keep analysts from catching on? "They will catch on if you do it to excess," he says. "Do not hype your stock. Make reasonable promises or projections as to what might be expected and be sure your people work hard to achieve those levels of performance. You will lose credibility if you hype stock and come in below expectations. It is important to be reasonable."
Stanley J. Bradshaw of Roosevelt Financial Group in Chesterfield, MO, agrees it's important to keep analysts' expectations close to reality. "If you have something good happening, analysts need to know. Hopefully, they will recommend the stock to their client. This means two things," he adds. "Make sure people know what is happening and how. and, if there are difficulties, do not take the market by surprise. The market hates surprise."
Last year, we suggested that "as CEOs learn more about what it takes to stay on top, perhaps we will see more continuity in our list from year to year. In turn, that would improve the value of the CEO Index as an investment and management tool." Having seen that continuity actually occur in 1994, we can think of no more appropriate wish for 1995 for those on the list and those who study this report every year than that they learn from this article. The CEO 100 study will be expanded next year to focus on upgrading the index as an investment and management tool, while our 100 CEOs work together to define the future best practices in stock-price improvement.
Donald W. Mitchell is chairman and chief executive of Mitchell and Co., a financial and management consulting firm in Waltham, MA. He is also chairman and CEO of OUTSTANDING CHIEF EXECUTIVE OFFICERS and SHARE PRICE GROWTH 100 , collaborative research organizations directed by leading executives and their companies, including many of the CEO 100.
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© 1995 Mitchell and Company
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