The Three Rules

Research Methodology

To learn what makes certain companies extraordinary, most analysts focus on the organizations themselves. This logical approach has a major failing: A review of extraordinary companies often reveals little more than a “concatenation of unlikely and impossible-to-repeat events.”

The research that uncovered the three “decision rules” involved high-level analysis of Compustat data from upward of 25,000 companies. This information spanned a half-century, or “nearly 300,000 company-year observations from 1966 to 2010.” It focused on the “entire observable lifetime of each company” studied. Besides noting each firm’s long-range return on assets (ROA), researchers examined each one’s “annual ROA performance” to identify specific “elements of advantage.” Those factors might include selling, general and administrative expenses (SG&A), gross margin, and current and fixed asset turnover. The study used an “explicitly statistically driven method to separate signal from noise.” Its “powerful combination of large-scale data analysis and in-depth case studies” meets rigorous research requirements.

Superstar Firms

In each industry, the study ...