The excitement surrounding the 500 rapidly growing private companies described in this issue raises fascinating questions. What happens to them next? Do they keep growing (can they, at such speed), or have they peaked too fast, soon to become just so many flashes in the pan? Or to ask in an engagingly hypothetical way: if you have the chance to invest in the INC. 500, to put up a private stake, should you?
To find out, we went back five years into our Cognetics database and followed each member of the 1982 INC. 500 through June 1987. Then we tested those companies against what we've learned about the performance of the economy as a whole.
We know already that the INC. 500 are part of a larger group of small, growing companies that collectively account for most of the employment growth in what we've come to call the New Economy. We know that they are relatively few in number. Our data suggest that about 500,000 companies (or 7% of the total of about 7 million) grow more than 20% per year, and about 80,000 businesses (or 1% of all companies) grow at a rate of more than 50% per year. By comparison, the average 1987 INC. 500 company has grown about 90% a year since 1982.
We also know that these fast-growing companies are volatile. Growth looks much more like a roller coaster than a ramp. In our broader database, we find that the single best predictor of a company's growth up to a two- or three-year horizon is previous decline. The best predictor of decline is recent rapid growth. And the best predictor of death is stability. Economywide statistics show that businesses that stop innovating and taking risks are almost twice as likely to fail as their more adventuresome counterparts.
Against this background, we measured the 380 companies of the 1982 INC. 500 for which we could obtain complete data. Could those companies sustain their qualifying performance for another five years? Are they less likely to go under? Did they do better than the overall universe of companies?
Our first discovery wasn't surprising. Of those we could study in depth, very few companies from the '82 list sustained their INC. 500 qualifying pace -- an average annual growth rate of approximately 60% (see figure 1). In general, the faster they grew to get on the 1982 list, the more likely they were to slow down. The converse is also true: slower-growing qualifiers were much more likely to keep up their pace, and were less likely to decline in the future. (Keep in mind that all these businesses were growing explosively. "Slower growing" does not mean "slow growing.")
FIGURE 1: THE CLASS OF '82 TODAY
INC. 500 % that % that
rank in maintained grew but % that % that
1982 growth more slowly declined failed
1-100 2.5% 72.2% 21.5% 3.8%
101-200 5.1 61.6 29.5 3.8
201-300 5.0 63.8 23.7 7.5
301-400 7.9 74.6 12.7 4.8
401-500 19.1 61.8 17.6 1.5
Though few 1982 INC. 500 companies maintained the pace that earned their listing, a huge majority did keep growing.
Some members of the class of '82 were not around for their fifth reunion. Our database reported 16 closures, and there were another 61 businesses we could find no trace of, even searching by phone -- taken together, a 15% disappearance rate. This may seem high for a group of companies that was so successful as recently as five years ago, but it still compares very favorably with a national rate during the same period of 24%.
The members of the class of '82 were far more volatile than the corporate population at large. At Cognetics, we have created a volatility index that measures a company's degree of instability by assessing its employment gains and losses over time. On this scale, the 1982 INC. 500 honorees have been five times less likely to be stable than the average U.S. company in the years since making the list. Only 12% of the INC. 500, compared with 62% of all U.S. companies, fell into the volatility index's "stable" range. What's more, almost half (42%) of the '82 INC. 500 were extremely unstable compared with only 15% of the overall corporate universe. It would appear that the INC. 500 superstars are not exempt from the rule that growth and volatility are inextricably bound.
So would these companies be worth the risk, on average, if you were offered the chance to invest in them? Here we must hypothesize a bit. Unfortunately, we have no data on profitability, clouding any assessment of INC. 500 company value either in 1982 or 1987, and making it tough to compare performance over that period with that of publicly held companies. We can, however, compare how well the sales of the 500 grew in relation to the sales of all companies. The growth performance of the class of '82, it turns out, was nothing short of extraordinary (see figure 2). A staggering 43% were still growing rapidly from 1982 through 1987, in contrast to only 4% for all corporations over the same period -- INC. 500 companies were 10 times more likely to be rapid growers.
FIGURE 2: THE CLASS OF '82 TODAY
Growth 1982 All
index INC. 500 U.S. companies
Negative 23.4% 14.8%
0-4 22.0 76.2
5-19 12.0 4.6
20+ 42.6 4.4
The growth performance of the class of '82 has been nothing short of extraordinary. (A growth index higher than 20 indicates extremely rapid growth, on a combined percentage and absolute basis.)
They may have slowed down, and they may be volatile, but the 1982 INC. 500 are still outperforming most companies by a large margin. If you could have invested in each, your investment would surely have outperformed any stock or bond average computed today.
In short, and as a close look at INC. 500 companies suggests, investing in the growth of the New Economy is a wild and crazy game. Virtually all the growth now comes from companies generically like the INC. 500, which means they are relatively few in number, are spread across all industries and places, and are privately held and hard to find. They begin their rapid growth almost from birth: 62% of the 1982 INC. 500 were just three years old or younger when their qualifying track record began. If you had waited until they had qualified to invest, you would have done very well -- but not nearly so well as if you'd become involved with them at their earliest stages.
When and if you can find a company like these and invest in it, its fortunes are very likely to bounce all over. It would seem wiser to invest in a large portfolio of 500 companies -- a strategy, however, that would only multiply the difficulty of finding just one such company in the first place. It is no wonder that few pension funds hold positions in INC. 500 companies. Said another way: it is a great tribute to the diversity and inventiveness of our financing system that the INC. 500 get financed at all.
What large-scale institutional investors are missing is the guts of the New Economy today. However 1982's INC. 500 companies may have vacillated over the past five years, their performance relative to the rest of the economy has been superb. In more general terms, more than 500,000 U.S. businesses are averaging better than 20% growth per year, and in 1986 the major investment-banking firms brought only 199 of them public.
So, our hats are off to the class of '82, for its resourcefulness in finding money as well as for the good use to which the money was put. To the formal investment community, a caution: you're missing most of the boat. And to the class of '87, our best wishes. May you thrive as well as did the generation before you.