Unusual Suspects Show Up in Profit Ranking

The winners in CFO’s full-year EVA Momentum ranking include Apple – of course – but also Weight Watchers, Priceline, and Midas.
Al EhrbarMay 23, 2012

The EVA Momentum ranking clearly debunks the notion that industry is destiny.  The top 25 companies in the ranking, which charts the profitability performance of companies in the Russell 3000 index, include ones from 19 different industries, ranging from likely winners in industries such as biotech and pharmaceuticals to very unlikely ones in trading and distribution, food and beverage, and conglomerates and machinery. 

The biggest winner last year was Vertex Pharmaceuticals, a Cambridge, Massachusetts-based biotech company that also led the ranking at the end of the third quarter.  Vertex also is the single exception to the rule about the five-year ranking separating out the consistent winners.  The company’s EVA performance, which is the change in economic profit , from 2007 through 2010 was downright lousy as it poured funds into new drugs that hadn’t come to market.  The investment paid off royally last year when Vertex finally came to market in the second quarter with Incivek, a new drug for hepatitis C.  Incivek sales have been so high, and so profitable, that they wiped out Vertex’s negative EVA Momentum over the prior four years and lifted its five-year average to 21.6%, which was No. 1 in its industry and No. 3 in the Russell.  Vertex  sales soared from $143 million to $1.4 billion last year while EVA shot up from minus $482 million to a positive $62 million. 

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Overall, U.S. corporations enjoyed stellar profits in 2011, but both the level of profitability and the rate of profit improvement began to ebb in the fourth quarter, according to CFO’s latest EVA Momentum Ranking.  The aggregate level of profitability of the companies in the index, measured by their EVA margin (or economic profit as a percentage of sales), was up by more than half a percentage point last year.  But the aggregate margin slipped a bit from the four quarters ended in September.

Great as the performance of Vertex was, six other companies can rightly claim equally impressive victories.  They are the ones that led their industries in EVA Momentum over one and five years and ended the five-year period with the highest EVA margins in their industries.  One, of course, is Apple.  It is No. 15 in one-year EVA Momentum, No. 4 in five-year Momentum, and No. 30 in EVA margin, and No. 1 on all three among computer companies. 

The only company that bested Apple on every rank was Liberty Media, owner of the Starz and Encore premium cable channels.  Liberty Media placed No. 2 on both one- and five-year EVA Momentum and on EVA Margin, with economic profits last year equal to 44.5% of sales.  Its EVA climbed from minus $251 million in 2007 to $592 million in 2010 and $1.346 billion last year.   Liberty Media and Vertex were the only companies with triple-digit EVA Momentum last year.  The four other super-stars that led their industries on all three rankings are NL Industries (commercial services and supplies), (internet and catalog retailing), Mastercard (IT services) and Sturm Ruger & Co. (leisure equipment and products).

The aggregate EVA margin for the nonfinancial companies in the Russell index rose by more than half a percentage point, from 2.32% of sales in 2010 to 2.84% last year.  But the aggregate EVA margin in the four quarters ended last September was just over 3%, which was the highest in at least 15 years.  An aggregate margin around 3% may not seem high, but bear in mind it is based on EVA, which includes a deduction for the opportunity cost of equity capital as well as debt, and is much more exacting than any other margin.  An EVA margin of 9% puts a company in the top decile of the Russell 3000.  The median EVA margin in the latest ranking was 1.5%.  That was up from 1.0% in 2010, but down slightly from 1.7% in the prior four-quarter period.

The median EVA Momentum for nonfinancial companies was 0.7% in 2011, meaning that the median company’s EVA increased by an amount equal to 0.7% of its 2010 sales.  That was down from a median EVA Momentum of 1.0% for the four quarters ended in September.   The table shows the 2011 EVA Momentum rank within the Russell index for the top company in each of 45 industries.  The table has two other ranks as well.  One is the company’s EVA margin in 2011.  The other is the ranking within the Russell of the company’s average EVA Momentum over the five years from 2007 through 2011.  The five-year ranking on EVA Momentum tends to separate the consistent high performers from that companies that happened to hit a particularly good patch in one year or are rebounding from cyclical downturns. 

Profitability performance also declined modestly in the fourth quarter.  The CFO ranking measures performance on the basis of EVA Momentum, which is the rate of change in a company’s EVA profit scaled to its sales in the prior period.  As a result, EVA Momentum permits direct comparisons of profitability performance across industries and across companies of different size.  It has a clear dividing line between good and bad performance, which is zero EVA Momentum.  A positive reading means economic profit has increased, while a negative reading means EVA has declined.  Scaling the change in EVA to prior-period sales, rather than simply taking the percentage change in EVA itself, allows comparisons of companies that have negative EVA with ones that are earning positive economic profits. 

Most industry leaders enjoyed outsize sales growth.  Excluding Vertex’s gargantuan leap, the sales gains for the No. 1 companies averaged 35%, nearly triple the average sales increase for the entire Russell nonfinancial universe.   Yet a few, like Formfactor Inc., Midas Inc. and PulteGroup, achieved top-of-the-class EVA Momentum by achieving significant reductions in their EVA losses on modest reductions in sales.  The archetypal winner, though, may be Weight Watchers International, which has maintained a solid, double-digit EVA margin while growing steadily. 

The one exception to the EVA rule that superior management can thrive in any industry is airlines.  The recently combined United Continental Holdings placed first in the industry, but its EVA Momentum was a disheartening minus 0.7%.  While it was first among airlines, it was a poor No. 1282 among Russell nonfinancials.

The ranking covers all nonfinancial companies in the index that had more than $100 million in sales in 2011 and 2007 (the base year for the five-year ranking) and share prices of $5 or more.   It excludes oil & gas companies because their profit performance often is whipsawed by swings in oil and gas prices.  The latest ranking covers a total of 1,608 companies; the period is four fiscal quarters ended in December, January or February.

CFO contributor Al Ehrbar is the COO of EVA Dimensions. To view the EVA Momentum Ranking for 2011 – Top Companies in Their Industry, and the downloadable Excel file of the EVA Momentum Ranking for all Russell 3000 nonfinancial companies, click here >>