The bestseller In Search of Excellence profiled companies that had been identified as “excellent” on the basis of outstanding financial performance as ranked by several measures of profitability and growth. This article examines 29 of the companies and finds that their financial health—as measured by the same ratios—began to decline virtually across the board starting right from the date on which they were selected as “excellent.” Furthermore, 39 companies ranked at the bottom by the same ratios showed widespread improvement over the next five years.

Over the five years, a portfolio of the 29 excellent companies wound up with 18 underperformers and 11 outperformers. It beat the S&P 500 by 1 per cent per year. A portfolio of the “unexcellent” companies ended up with 25 outperformers and 14 underperformers. It beat the S&P 500 by over 12 per cent per year.

The two portfolios had almost identical betas and standard deviations. The beta of the excellent portfolio was 1.18 and its annual standard deviation was 17.7 per cent. The unexcellent portfolio had a beta of 1.17 and annual standard deviation of 18 per cent. The unexcellent portfolio, however, had a monthly alpha (non-market return) of 1.0 per cent, compared with the excellent portfolio’s 0.2 per cent. Obviously, analysts must question the naive assumption that history can be simply extrapolated and must carefully integrate into the stock selection process a rigorous valuation decision.