In Search of Excellence at (Almost) 25 … and Standing Tall

In Search of Excellence will be 25 next year—believe it or not. A few days ago a Web posting suggested that Bob Waterman and I had fudged the data in the book.

It's simply not true.

But if that perception is rumbling around in cyberspace, it's all my fault.

I did an interview on the book with my great pal Alan Webber, Fast Company founder, a couple of years ago. I made the wretched mistake, in casual conversation, of saying we'd "fiddled the data" for In Search of Excellence.

What I meant had nothing to do with "fudging," or "fiddling," but was a comment only on the differences between our methodology for company selection and that of Jim Collins in Good to Great. Jim apparently had no prior convictions about which companies he'd examine, and created his list by applying certain financial criteria to a huge company database—and sight unseen, a set of superb performers emerged. By that standard, Bob Waterman and I did it "backwards." We were enamored of the "excellence idea," wanted to write about it, and thence sought initial "excellent company" nominations based on McKinsey and academic and corporate experts' subjective evaluations; only after getting a "subjective" list of nominees did we apply the financial screens that caused any number—such as GE (this was pre-Welch)—to drop off the list. Thus, by fiddling I simply meant that we hadn't followed a pure model of starting from a big list and using only financial data to extract unforeseen winners.

(Fact is, any like process is about 90% subjective—e.g., if you use-juggle different data screens, different years, you will get wildly different results/lists.)

For what it's worth, Bob and I subjected our subjectively determined candidates to six tough financial hurdles (see In Search of Excellence, page 22 et seq.), three representing growth, three representing absolute financial returns. Growth measures: compound asset growth; compound equity growth; average ratio of market value to book value. The "absolute" measures were: average return on total capital; average return on equity; average return on sales. We did our research in 1980, and arbitrarily used data covering 1961–1980. To qualify, a company had to have been in the top half on at least four of the six measures for the full 20-year period. Most handily exceeded this standard, but 19 of our original 62 company nominees dropped out, and we concentrated our research on the remaining 43.

Far more interesting, I think, is that given our subjective nomination process, we ended up examining companies that, in 1980, virtually no one had looked at. Absurd as it may seem, these "stealth" "cool" companies, circa 1980, included: Emerson Electric, Texas Instruments, Hewlett-Packard (then a $1-billion firm), Frito-Lay/PepsiCo, Johnson & Johnson, 3M, Caterpillar, Marriott, McDonald's, Intel, Disney, Delta Airlines, and, yes, little Wal*Mart.

While I'm on the topic of In Search of Excellence and retrospective perceptions thereof, I'll deal with the second "charge" against the book; namely, that several of "our" companies "failed." (For some wholly unknown reason, some people say "most of" "our" companies failed????) To be sure, the likes of Wang and Atari and Kmart are today embarrassments. Nonetheless, the overall performance of "our" firms has been little short of stunning. In 2002, on the 20th anniversary of the book, forbes.com held our publicly traded companies up to a high-amp searchlight:

One remarkable fact about In Search of Excellence remains: Its list of companies have held up quite well over time. The book, which our panel of experts recently voted the most influential business title in the last 20 years, focuses on 43 "excellent" companies. The list contains just a few arguably embarrassing picks, Atari and Wang Labs being the most prominent. But overall, the companies Peters and Waterman called excellent have easily outperformed the market averages any way you slice it.

In Search of Excellence didn't name the biggest companies and ride with winners: In 1982, when the book was published, just three of the 43 companies ranked among the top 25 by sales on The Forbes 500s. And just 22 of the 32 public companies were among the 500 largest. Those 22 ranked, on average, 125th on The Forbes 500s by sales.

Over the years, the companies grew. By 2002, 24 of the firms were among the largest 500 public companies, with an average Forbes 500s sales rank of 99.

The authors picked big companies considered "innovative and excellent" in a variety of industries that had shown strong growth and profitability between 1961 and 1980. The book doesn't purport to be an investment guide, but investing in these excellent companies would have been a very wise choice both in the short run and the long run.

Over a five-, 10- or 20-year period, the Excellence Index—an unweighted basket of the 32 public companies among Peters and Waterman's 43—substantially outperformed the Dow Jones Industrial Average and the broader S&P 500. Since October 1982, when the book was published, the companies on the authors' list earned an average total return of 1,305%, or 14.1% annually. This return outdistanced the DJIA companies, which earned an average annual return of 11.3%, and the S&P, whose companies earned an average annual return of 10.1%.

In other words, if you invested $10,000 in the Excellence Index 20 years ago and then did nothing at all, you would have $140,050. An equal investment in the Dow would have yielded just $85,500.

The Excellence index gets a boost from star performers such as Wal*Mart Stores and Intel. But its median company performance also easily bests the averages for each of the five-, 10- and 20-year periods.

Some might assume it easy to pick 30 or 40 companies that would outperform the Dow. But precious few mutual fund managers do it—even though that's their job and they can change their mix of companies at will. ...

Mistakes in In Search of Excellence? Absolutely. Things I'd say differently? Absolutely. But overall ... coulda been a lot worse. (And, boy-o-boy, do I ever wish I'd invested in "our" companies in 1982! Frankly, I considered it, but decided that such a move would destroy my credibility.)