Most Profitable CEOs Get Smallest Gains in S&P 500

Most Profitable CEOs Get Smallest Gains in S&P 500

Dec. 28 (Bloomberg) -- Brown-Forman Corp.’s Paul Varga and Johnson & Johnson’s William Weldon are among chief executive officers left behind in the 2009 stock-market rebound even after they created the most value for their companies.

Brown-Forman, the maker of Jack Daniel’s whiskey and Southern Comfort liqueur; J&J, the world’s largest health- products company; and 30 other Standard & Poor’s 500 Index companies rallied less than 10 percent this year as their managers posted better-than-average sales and efficiently invested capital, data compiled by Bloomberg show. Companies with the biggest stock gains had among the lowest scores in a ranking known as economic value added.

Money managers ignored profitability to snap up stocks that dropped the most in the credit crisis, leaving opportunities for value investors in 2010, say Raiffeisen Capital Management and Credit Andorra. They’re buying this year’s laggards, betting companies with the highest returns on shareholders’ capital will be rewarded as the Federal Reserve prepares to raise interest rates and the government removes stimulus.

“The best rally in our lifetime has left even more opportunities,” said Vienna-based Herbert Perus, head of global equities at Raiffeisen, whose team helps manage $36 billion and has bought J&J shares. “Well-managed companies with extremely good balance sheets were left behind.”

Creating Value

Fewer than 215 companies in the S&P 500 created value in 2009 as the U.S. economy experienced the worst contraction since the Great Depression, according to data compiled by Bloomberg based on consulting firm Stern Stewart & Co.’s EVA model. Their so-called return on invested capital exceeded the cost of funding their operations, the economic value added data show.

Futures on the S&P 500 expiring in March added 1.80, or 0.2 percent, to 1,123.80 as of 2:38 a.m. in New York.

Thirty-two of those companies are projected to increase sales or report a smaller drop than the 5.9 percent median for the S&P 500 this year while posting an equity-market advance that trailed 10 percent, Bloomberg data show. Shareholders missed out as the benchmark index for U.S. stocks rose 25 percent in 2009 and 67 percent during the past nine months, the most in seven decades, after the government lent, spent or guaranteed more than $11 trillion to end the financial crisis.

Fluctuations in EVA are four times more likely to rise and fall with share prices than per-share earnings, according to Joel Stern, the chief executive officer and chairman of New York-based Stern Stewart. He helped develop the measure in the late 1980s and uses it to advise corporations on strategy.

More Reliable

EVA, also known as economic profit, is a more reliable gauge of management performance because it treats the price of intangible assets such as research as an investment, while measuring all returns against the cost of raising money for the business, according to Stern.

The argument that “earnings per share is a driving force on value fails in the face of actual evidence,” he said. “It’s not earnings or dividends that create value, but economic performance.”

Varga posted a return on invested capital of 15 percent during the past year at Brown-Forman, according to data compiled by Bloomberg. That beat the Louisville, Kentucky-based company’s so-called cost of capital by 7.8 percentage points. Brown- Forman’s shares have added 3.8 percent since Dec. 31.

The liquor maker posted more profit than the average analyst estimate in four of the past five quarters, Bloomberg data show, and boosted its earnings forecast to $2.95 to $3.15 per share for the year ending in April on Dec. 8. Phil Lynch, a spokesman at Brown-Forman, declined to comment.

Eliminating 7,000 Jobs

J&J exceeded its cost of capital by 9.3 percentage points in the past four quarters. The company, based in New Brunswick, New Jersey, has beaten the analyst profit forecast 14 straight quarters and CEO Weldon said Nov. 3 that he will fire more than 7,000 workers to eliminate layers of management to free up money to invest in more profitable businesses. The shares rose 8.1 percent in 2009. Bill Price, a spokesman, wouldn’t comment.

Procter & Gamble Co., the world’s largest consumer-products company, reported first-quarter profit on Oct. 29 that fell less than analysts estimated and raised its full-year forecast for sales growth. The stock lost 0.9 percent in 2009.

Robert McDonald, who took over as CEO of the maker of Crest toothpaste and Pantene shampoo in July, is boosting promotional spending for the company’s top brands to increase revenue. Company spokespeople weren’t immediately reachable for comment.

‘Extremely High’

Investors favored companies with the weakest finances during the nine-month rally in the S&P 500, said Nick Skiming at Ashburton Ltd. That’s partly because those shares suffered the most during the credit crisis as traders priced in the possibility of a depression following the collapse of Lehman Brothers Holdings Inc. in September 2008, he said.

“The poorer balance-sheet stocks rallied because they were oversold,” said Skiming, who helps oversee about $2 billion from Jersey, the Channel Islands, and owns shares of Kraft Foods Inc. and Procter & Gamble. Northfield, Illinois-based Kraft is also among the 32 companies that passed the EVA test. “Risk of default was extremely high. Going forward, the rally will broaden out and the blue chips will start to rally.”

The S&P 500 plunged 57 percent through March 9 from a record high of 1,565.15 in October 2007, wiping out $11 trillion in value. More than $1.7 trillion in bank losses and writedowns stemming from the collapse of the subprime mortgage market caused the collapse of Lehman Brothers and Bear Stearns Cos., both from New York, and forced the U.S. government to bail out American International Group Inc. last year.

$182.3 Billion Bailout

Bear Stearns was bought by JPMorgan with the Federal Reserve’s help in 2008, while Lehman failed to find a buyer and filed for the biggest bankruptcy in U.S. history. New York-based AIG, once the world’s largest insurer, was rescued last year with a bailout that increased to $182.3 billion.

The 25 companies in the S&P 500 who did worst according to EVA this year posted a median rally of 95 percent in 2009, compared with the 51 percent median gain for the 25 that did the best. The trend will probably reverse, said David Macia, U.S. fund manager at Credit Andorra’s Credi Invest unit in Andorra La Vella, Andorra.

“The market will be much more selective and will bet for companies that give more certainty,” said Macia, whose firm oversees $5.7 billion. “It won’t be such an indiscriminate rally. Companies will now need to prove their ability and show they can boost revenue.”

Changes in EVA are a better indicator of how well CEOs are investing money and the prospects for their stocks, according to Stern and Michael McConnell, director of research for Credit Suisse Group AG’s HOLT division, which tracks a similar measure of economic profit.

Profit Momentum

“What’s important is performance relative to expectations,” McConnell said. “You can look at the change and momentum in economic profit. Companies that improve their performance will do better in the equity market.”

A HOLT index of 60 U.S. stocks with the best economic profit prospects has gained 195 percent since April 1996, compared with about 112 percent for the S&P 500 including reinvested dividends.

Joseph Keating of RBC Bank said he’s buying companies with “reliable” revenue growth, including J&J and Purchase, New York-based PepsiCo Inc., the world’s largest snack maker. PepsiCo beat its cost of capital by 13 percentage points this year. Keating said investors are likely to shift away from companies with the worst prospects.

“We clearly way overshot the downside because of people discounting the worst-case scenario,” said Keating, chief investment officer of Raleigh, North Carolina-based RBC Bank, which oversees $3 billion. “Now it’s more fundamentals. We’re going to invest in companies that we can begin to discount into the present value of the stocks some stream of future earnings.”



The following 32 companies created economic value this
year, increased sales or posted a smaller revenue decline than
the 5.9 percent median among S&P 500 stocks, and rose less than
10 percent in U.S. trading. Stock symbols are in parentheses
after company names.

Abbott Laboratories (ABT US)
Aflac (AFL US)
Amgen (AMGN US)
Apollo Group (APOL US)
Automatic Data Processing (ADP US)
Baxter International (BAX US)
BB&T (BBT US)
Biogen Idec (BIIB US)
Brown-Forman (BF/B US)
C.R. Bard (BCR US)
Cephalon (CEPH US)
DeVry (DV US)
Dun & Bradstreet (DNB US)
Exelon (EXC US)
Family Dollar Stores (FDO US)
First Solar (FSLR US)
Flir Systems (FLIR US)
Fluor (FLR US)
FPL Group (FPL US)
Gamestop (GME US)
Gilead Sciences (GILD US)
H&R Block (HRB US)
Hershey (HSY US)
Jacobs Engineering Group (JEC US)
Johnson & Johnson (JNJ US)
Kraft Foods (KFT US)
Procter & Gamble (PG US)
Progress Energy (PGN US)
Safeway (SWY US)
SAIC (SAI US)
Stericycle (SRCL US)
Wal-Mart Stores (WMT US)

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