Barron's -

The World's Most Respected Companies

The World's Most Respected Companies

By Vito J. Racanelli 15 February 2010 What price respect? If the concept seems too high-minded for pecuniary assessment, just consider the top scorers in Barron's latest ranking -- The World's Most Respected Companies. Most are companies whose shares have been strong performers. In fact, when it comes to calculating asset values -- physical, financial or reputational -- Wall Street is never at a loss. Investors pay up for respect, in part because respected companies tend to hold their value longer."Respected companies aren't going to fall as far in the bad times, and they come back better," says David Hartzell of Cornell Capital Management, a participant in the survey that helped us produce our list. In 2009's roller-coaster market, the top-ranked stocks generally experienced lower volatility and outperformed during the bear leg. And now, even after the broad market's furious rally, the value of respect is still felt: For the most part, shares of the most respected companies are either above or not much below their pre-Lehmanbankruptcy levels, and have beaten the market since that crisis erupted. Indeed, Apple (ticker: AAPL), which topped our list, is above its pre-crisis stock price. If an Apple shareholder fell asleep in the summer of 2008 and didn't awaken until Christmas 2009, he'd hardly notice anything had been amiss, based on the stock price. It's not uncommon to see a few changes at the top of our annual ranking, and this year is no exception. The top five scorers are mostly a reshuffle of last year's top percentile. Johnson & Johnson (JNJ), a perennial leader, slipped to No. 2 from '09's No. 1, and Berkshire Hathaway (BRKA) dropped to fifth place from second. The ever steady Procter & Gamble (PG) remained at No. 3, and IBM (IBM) jumped 10 notches to fourth place. But Wal-Mart Stores (WMT) fell to No. 12 from fifth place; the discounter's stock was one of the best to own in 2008, but not last year. Conversely, there is a heavy price to pay for disrespect. Shares of the least respected corporations in our 2010 ranking, such as Citigroup (C) -- dead last -- are so far below pre-Lehman levels that a recovery to those halcyon days seems unimaginable, despite the broad market rally. Russia's Gazprom (OGZPY), No. 99, also is significantly below pre-crisis levels. Defining respect isn't easy. "It's a difficult concept," says Paul Jackson of Paul Jackson & Associates. "You might think a company like McDonald's [MCD] isn't respected. All they do is make burgers. But they make millions of them, and they are very good at it. Are they are respected because of the innovations or because of the good profit

numbers?" Mickey D's, which arguably deserves respect for both, is No. 7 this year, just as it was in 2009.

Survey participants say respected companies have strong management, good governance, valuable products and services, and strong stock returns. They treat their shareholders, customers and employees well. They act ethically. And while some money managers name respect as the first cut in their investment process, others say respect is more often the result of a sound investment process. John Roberts, a portfolio manager with Denver Investments, contends that respect answers the question "Is management going to be a good steward of our clients' money?" "Respect takes a long time to build and it's easily destroyed," he says. The most powerful example of that is General Electric (GE), once a textbook example of Corporate America at its best. GE has continued a precipitous slide in our survey that began after 2005, when it topped the list, and that recently has intensified. "GE was a financial company dressed up in industrial drag," says David Anderson of Anderson Hoaglin. GE plunged in our rankings to No. 74 from 43 last year, and is now just above the bottom quartile, something that only a couple of years ago few probably would have considered possible. Likewise, Wells Fargo (WFC), No. 49, down from 21, and ConocoPhillips (COP), No. 46, from 28, have lost significant respect among the institutional money managers who participate in our survey. Other companies, however, have seen their respect scores rise sharply. Google (GOOG) climbed to No. 8 from 23, and Qualcomm (QCOM) jumped to No. 28 from last year's 53. Each year Barron's surveys professional money managers about their views of the 100 largest companies in the world based on total stock-market capitalization on Dec. 31, as determined by Dow Jones Indexes. This year's survey, conducted with the help of Beta Research in Syosset, N.Y., elicited responses from 70 investors across the country, ranging from proprietors of small advisory firms to the chief investment officers of money-management giants overseeing hundreds of billions of dollars. Participants were asked to select one of four statements for each company: Highly Respect, Respect, Respect Somewhat or Don't Respect. A point value was assigned to each response, with the highest accorded to Highly Respect, and a mean score was tabulated for each. In the case of ties, the higher ranking went to the company

with the most Highly Respect votes. The managers also were asked to rank the factors they consider in determining respect for corporations. Since stock-market capitalization was key to inclusion on the list, share-price changes played a significant role in determining the universe of companies considered. This year 22 new names joined the list, replacing companies whose relative market value shrank in 2009. The largest concern, No. 18-ranked ExxonMobil (XOM), had a market cap of $323.7 billion as of Dec. 31, while the smallest, No. 52-ranked LVMH Moet Hennessy (MC.France), had a market value of $55.1 billion. Other themes emerged in this latest poll. For one, the average of the 100 mean scores rose sharply, to 2.25 from 1.87, which perhaps isn't surprising after the stock market's 26% rise last year. Higher stock prices garner respect -- or is it just plain relief after a good year? Moreover, among the 78 companies included in both this year's and last year's survey, 59 saw their mean scores rise. In 2009, mean scores fell for 61 companies, relative to their 2008 performance. Among the newcomers to this year's list -- and some returnees from prior surveys -were several mining and metals producers, and banks. Drug and utility stocks, in contrast, were represented disproportionately among the companies dropped. Stocks tossed out included Eli Lilly (LLY) and Endesa (ELE.Spain), while new names included Goldman Sachs (GS), No. 30; Rio Tinto (RIO), No. 70, and Daimler, No. 48. This year's survey also included six more non-U.S. companies than the '09 poll, a reflection of the sharp stock-market gains realized last year by many foreign companies, especially those, such as Brazilian miner Vale (VALE), No. 72, and Russian gas producer Rosneft (ROSN.Russia), No. 98, based in emerging markets. Institutional investors still consider strong management their No. 1 criterion in determining success. This year, however, ethical business practices jumped to No. 2, up from third most important last year. That is understandable, given the drumbeat of criticism about allegedly dodgy practices throughout the corporate world and on Wall Street, in particular, in the past 12 months. Sound business strategy ranked third, and revenue and profit growth, tied for fourth. While these are all important characteristics, to ignore share performance as a factor would be a mistake. Investors seem to rate companies at least in part on whether their stocks are in or out of favor. What, besides rising shares, could explain the return of certain banks to prominence in our rankings? Google's shares more than doubled last year, which also might have something to do with the company's ascent in our respect rankings. Because the survey was e-mailed to participants just as the company's censorship battle with China was erupting, it isn't clear that our respondents took Google's actions into account. In a follow-up interview, however, Roberts of Denver Investments said that while irritating the Chinese government and risking revenue in China might seem as if Google isn't looking out for shareholders in the short term, management's concern likely is with the long term. "Does it want to be known as caving in to censorship?," he asks. "This might not be answered for 20 years." Share performance undoubtedly played a role in elevating investors' respect for Apple, but there is plenty more than stock price behind the company's first-place finish.

John Cregan, veteran money manager at Hotchkiss Associates, a unit of United Capital Financial Advisers, says he admires Apple because the company "is at the top of the list of seeing around corners. They aren't out there trying to find out what their customers want, but saying rather, 'Look at this advancement in technology. It enables us to do this. You might not want it yet or know what to do with it, but you will want it and we are going to build it.'" Cornell Capital's Hartzell thinks Apple's new iPad will be a bust. Yet he gives Apple CEO Steve Jobs credit for "taking a big cut" at the ball. The way things have fallen into place, Jobs could probably get himself elected king of the world. But contrarians would note that the company's stock is so beloved that it might not have much gas left, at least in the short term. Both Johnson & Johnson and Procter & Gamble have done well in our survey over the years, and continue to earn respect on Main Street as well as Wall. The public still gives J&J points for its quick and deft response to a Tylenol cyanide-poisoning scare in the early 1980s, while investors applaud it for walking away from a battle with stentmaker Boston Scientific (BSX) over the purchase of Guidant. P&G scores for its consistency, industry leadership and a clear focus on its direction and marketing. For all the respect J&J's steady profit and dividend growth have earned it among investors, Marc Heilweil, manager of the Marathon Value Portfolio (MVPFX), notes that "a point not often made is how important respect is to the workforce, and what having a mission means for people who work for J&J." P&G, he adds, gets kudos for removing managers on a timely basis when they don't work out. "P&G understands it has to add value to commodity products," he says. IBM's sharp jump in this year's survey also seems well-deserved. In the past the company often didn't get the credit it merited, says Charlie Bobrinskoy, a portfolio manager at Ariel Investments. "Earnings are up a lot every year without a major hiccup," he says, noting IBM has "changed stripes from a mostly mainframecomputer business to services and software." The stock, which trades for about 11 times this year's estimated earnings of $11.12 a share, "should get a market multiple" of 14 times earnings, he says. Berkshire Hathaway's modest decline this year could be due, in part, to CEO Warren Buffett's much-criticized decision to pay a rich $34 billion for railroad giant Burlington Northern (BNI). Marathon's Heilweil maintains Buffett was "holding on to too much money. The enterprise is too large for anyone but him to run. He should have returned the cash to shareholders." Buffett doesn't lack for defenders, however. "He wanted to put capital to work where he wouldn't make a mistake, and remove a large capital-allocation risk from his successor," says John De Gan, of Harbor Advisory. Toyota Motor (TM), which ranked No. 6 this year, up from No. 8, long has had a stellar reputation among both money managers and consumers. The company's shocking move this month to recall several models for safety concerns came too late for most respondents to address in their surveys. In interviews in recent days, money managers were divided on how well they thought Toyota was handling the problem. But nearly all thought the company's safety problems would hit them hard in next year's Most Respected survey.

Among bank stocks, Wells Fargo's decline drew heated comments from survey respondents. "They were one of few banks to object publicly to TARP [the federal government's Troubled Asset Relief Program funds] . . . and got handed a big, stinky pile of problems not of their own making," says Stephen Ethridge, partner at Stewart and Patten. But Ariel's Bobrinskoy contends Wells "isn't as different from other troubled banks as supporters claim. Wells Fargo still has a lot of risk because [of] exposure to residential real estate and commercial property" in California. ConocoPhillips' respect score also dropped, in part because investors have been critical of the company's acquisitions. It purchased Burlington Resources for $35 billion in 2006, near the top of the natural-gas market, while Phillips acquired refiner Tosco in 2001, prior to its merger with Conoco and at the tail end of the refining boom. Said one money manager, who declined to be identified: "They wanted to be a supermajor, but the company's allocation of capital has been poor. The Burlington deal was not ideal." Once again, money managers showed disdain for Russian and Chinese companies; two Chinese outfits and three Russian oil companies ranked among the bottom seven on this year's list. But none ranked lower than Citi. To Ariel's Bobrinskoy, the bank probably is worth a look, as "respect is a trailing measure" of performance. As with General Electric, Citigroup stands as a reminder to corporate chieftains not to take investors' respect for granted. That such a global institution, which not long ago was held to be the epitome of a hard-charging, world-leading American banking system, has fallen so quickly and to such a low state is as instructive as it is unfortunate. Once a company's downhill slide intensifies, the loss of investor respect is hard to reverse. GE's and Citigroup's fall from grace bring to mind a line from a Cormac McCarthy novel: "Nothin' wounded goes uphill . . . . It just don't happen." Unless, that is, management concentrates on healing what hurts, spurred in part by a drive to recapture investors' respect.