(FORTUNE Magazine) – WHY DON'T WE do this more often?'' the 500 largest industrial companies might say of 1988, a year of splendid profitability. ''We do,'' 21 members of the group could answer. These are the stars of the FORTUNE 500 identified by this magazine in a special study of sustained profitability. Some are relatively new to the list, such as Liz Claiborne and Commerce Clearing House, and some have been standouts there for many a year. In general, these are the rich of big business and, yes, they are different. Just look at their stellar stock performance. But their behavior beams down important messages to all managements. We picked out these 21 by looking at return on equity -- the ratio, that is, of aftertax profit to stockholders' equity -- which is a fundamental guide to how well a company's management is employing the owners' money. Our span of measurement was ten years. To shine as a star, a company had to have averaged at least a 20% return on year-end equity over the 1979-88 decade and been so consistent that it never dropped below 15%. We knocked out companies that met the tests only because they sold off assets. In other words, we were looking for year-in, year-out performers. The standards are rigorous. We know that because we have some fallen stars from a 1984 study to lament. We know it also because the FORTUNE 500 as a whole has earned far less: Its median return on equity over the 1979-88 decade averaged only 13.3%. Further, logic proclaims that a long-running 20% is a marvelous thing. It is equivalent to a 20% savings account, on which part of the return is typically paid out as dividends and some is retained, also to earn 20%. Where else can an investor park money and share in such earnings? Breaking into stardom was especially tough when FORTUNE made its first sweep five years ago. We were then examining a decade, 1974-83, that hammered business, testing it with no fewer than three recessions, rising energy prices, and pervasive inflation. Only 13 companies among the 500 industrials met our tests. Why more now? First, this last decade, which included the longest peacetime economic expansion ever, was easier. Second, some of today's stars, like the rest of the corporate world, have increased their use of debt and thereby bolstered their returns on equity. Third, a kind of pseudo-shareholder, the U.S. government, helped out by cutting corporate tax rates, from 46% to 34%, thus reducing its share of the profit pie. Even so, from top to bottom this is a financially superb assembly of companies, which share certain characteristics. Most are quality obsessed, cost conscious, and driven to be even better than they are. They tend to be conservative in capital structure; none owe their place among the stars to a sliver of equity and a slab of debt. They can afford to be conservative. Most enjoy a flood of cash every year, thrown off by some of the most rewarding operations in the world. On page 60, in fact, we present a first-time-ever ranking that draws on the segment data presented in annual reports and spotlights the best -- and worst -- businesses of these 21 best companies. Can you begin to comprehend an operation that annually makes nearly 300%, pretax, on assets? One company claims such performance -- and the reality, as you will see, is even better than the claim. The problem with the cash these businesses throw off is that it has to be invested. Most of the 21 contend with this enviable headache day in, day out, and in their ''solutions'' have often proved strikingly inept. For all their excellence in other ways, many have erred by not sticking to their knitting. The exemplar in FORTUNE's galaxy is Liz Claiborne Inc., whose ten-year average return on equity, a dazzling 40.3%, makes it first among the 21. This ) is a company that did not even exist until 1976 and in 1979 had only $48 million in sales. But that was fasten-your-seat-belts time, recalls the company's vice chairman, Arthur Ortenberg. About then, he says, the company's chairman -- who is his wife, Elisabeth Claiborne -- was coming to ''the horrendous realization that she was now in the process of clothing all of America.'' The chairman knows a spousal overstatement when she hears one: ''Not quite all, at that point,'' she demurs. Ortenberg, nonetheless, had the future stitched out: Customers, particularly working women, thronged to buy his wife's classically designed, well-made clothes. Last year Liz Claiborne -- the company, led by the person -- was No. 299 on the FORTUNE 500 with $1.2 billion in sales.

Then, as if to say ''mission accomplished,'' the Ortenbergs announced in February that they would retire in June and think about climbing other mountains, real ones. The new chairman will be Jerome A. Chazen, 62, who knew the Ortenbergs before they started the company, joined it in 1977, and has been a lead player in its progress. A tough act to follow he's got. But the company, he says, has ''a life of its own now.'' Besides, he adds wryly, challenge is a familiarity in the fashion world, where ''you're only as good as your last line.'' THAT BROMIDE also has meaning at an anti-exemplar, SmithKline Beckman, which has dropped out of the firmament. Ten years ago it was a seasoned, solid company, blessed with a wonder drug, the ulcer therapeutic, Tagamet. ''A pharmaceutical gusher,'' to quote Chairman Henry Wendt, it pushed the company's returns to the sky. On FORTUNE's list of five years ago, SmithKline ranked fourth among the galaxy of 13. But many outsiders had long wondered whether competition might develop for the drug. ''How can you improve on Tagamet?'' a SmithKline executive reassured a FORTUNE reporter in 1980, and for a time no one did. Then Glaxo Holdings, a British company, brought on Zantac, a stronger drug that began to perforate Tagamet's market. Along the way, SmithKline overpaid for an acquisition, Beckman Instruments, and despite huge research spending failed to produce any important new drugs. Last summer, shocking Wall Street, SmithKline suddenly disclosed that profits would be down for the year. Months later, it announced it would lay off 1,600 employees and take a restructuring charge of $293 million. ''This company is colossally screwed up,'' says a money manager who used to own the stock. ''They had the ulcer market -- they were there first. The point is that nothing lasts forever if you've got crummy management.'' A second point is that SmithKline had a 1988 return on equity of only 14.8%, not enough to stay in the club. As a dropout from FORTUNE's high-return list, SmithKline has four others for company. The stunner is IBM, whose return on equity for the last three years has been under 15%. Asked in 1984 what he thought the probabilities were of IBM continuing to meet the list's statistical tests for another ten years, Frank T. Cary, then chairman of the executive committee, whipped back: ''100%.'' Two other dropoffs have slipped to averages around 19%, which still is excellent: Worthington Industries, a specialty steel company, and Dover Corp., a diversified metal-bender. The fifth among the fallen, Mitchell Energy, an independent oil and gas producer, sank precipitously to meager profits with the collapse in energy prices. As the dropoffs prove, the stars do not enjoy lifetime tenure. All the more striking, then, is the enduring performance of eight survivors from 1984. In order of appearance on this year's list: Kellogg, American Home Products, Deluxe Corp. (until recently called Deluxe Check Printers), Maytag, Merck, Dow Jones, Coca-Cola, and Nalco Chemical. A hand, ladies and gentlemen: You are looking at a collection of financial wonders. The eight hold title to some powerhouse brand names, but are notable mainly for their diversity. The newborn stars, as well, sprawl over the business landscape, though some come in twos, as if preparing to board an industrial Noah's ark. Besides Liz Claiborne in apparel, there's VF Corp., which got its initials from Vanity Fair lingerie but is known chiefly for its Lee and Wrangler blue jeans. Two arrivals are pharmaceutical companies that have steadily increased their returns: Abbott Laboratories and Bristol-Myers. Two are tobacco types: Philip Morris and UST, whose Skoal and Copenhagen brands make it the king of smokeless. And two are publishers: Washington Post and Commerce Clearing House, whose tax reports keep lawyers and accountants up to speed. Washington Post's chief executive, Katharine Graham, and Liz Claiborne are another kind of pair. Only three FORTUNE 500 companies are headed by women. One of them, Warnaco, whose chief is Linda Wachner, has lately been running losses. But Graham's and Claiborne's companies captured two spots out of 21. Statistically, companies led by women are entitled to only one-eighth of a spot. This writer, for one, does not find the over-representation of women surprising. Four of the five remaining newcomers, Anheuser-Busch, Jostens, Noxell, and Tambrands, get their returns and their reputations mainly from the business they were built on. Anheuser-Busch claims 41% of the U.S. beer market, up from 33% five years ago, and is determined to get to 50%. Jostens plies the education market: It sells class rings, yearbooks, and photos to students, and computer systems to schools. Noxell's cosmetics and toiletries -- Cover Girl, Clarion, Noxzema -- fill the display racks of mass merchandisers. Tambrands, which changed its name from Tampax, owns about 60% of the U.S. tampon business. Tambrands also has an oddball distinction for a member of the 21: management trouble. After losing the confidence of his board, Tambrands Chief Executive Edwin Shutt Jr., 61, recently ''retired,'' a departure that proves high returns don't necessarily guarantee the boss his job. Part of Shutt's problem was a diversification program that hasn't produced much. THE 21st COMPANY, EG&G (its founders' initials), is so complex that Wall Street analysts pale at figuring it out. The company has 152 businesses, most technologically based and some with only $3 million or so in sales. Among EG& G's products are meters, valves, and X-ray equipment used at airport security checkpoints. But the company also manages many government facilities, among them the Kennedy Space Center. When the Challenger shuttle exploded in 1986, EG&G helped analyze debris, answer mail, and devise new safety procedures. Remember the business that makes nearly 300% on assets? That's the manufacturing, research, and managerial work that EG&G does for the Department of Energy, at such nuclear facilities as the Nevada Test Site. Wouldn't you know that the return comes from government contracts? The plot thickens if you scrutinize this enterprise. EG&G's 1988 annual report shows the Energy Department business earned an operating profit of $22 million last year on $8 million of assets. But, says EG&G's chairman, John M. Kucharski, 53, this operation does not have plant, equipment, inventories, or even a bank account: To pay its employees, it simply writes checks on a special government account. What the operation does have is a periodic fee that it charges the feds. So the assets here, says Kucharski, are simply the receivables that materialize briefly while EG&G is waiting to be paid. The reality, says Kucharski cheerfully, is ''zero investment.'' But, he adds, ''Bean counters do not deal well with infinity,'' which is why the segment data present the receivables as assets. Infinity an investor can't match. But as long as he does not pay wildly for a high return, he can expect the company delivering it to give him long-term results that beat the stock market. As a whole, these 21 did not disappoint. Twenty of the group were publicly traded at the end of 1978, and their median total return to investors -- stock appreciation plus dividends -- over the following decade was an annual rate, compounded, of 21.6%. That's about four percentage points better than the 500 did as a whole, which over time makes a ton of difference. The prize for best annual total return, 35.4%, goes to VF, which ten years ago was a relative unknown, just beginning to hit its stride. The worst return, though it is still not bad, was Nalco's 14.9%; its stock has just been hanging around since 1983, partly because the oil bust hurt sales of its specialty chemicals. Liz Claiborne, which went public only in 1981, has been the real knockout. Its stock price is up 14-fold since then, and the company has tossed in some small dividends. Annualized total return: 43%. As the last decade began, an investor could not have known, of course, just which companies were going to produce star-quality returns on equity. But he could have looked at FORTUNE's first list of stars when it was published in April 1984, and decided to buy. Five of these companies, remember, have fallen from grace. Nonetheless the median total return of the 13, annualized, has been 17.8%. In contrast, Standard & Poor's 500-stock index provided a total return over the period of only 11.4%, which is two tons of difference. Kellogg and Merck led the parade with superstar returns: 40% and 35% annualized. Ten other companies had positive returns, ranging from Deluxe's 32% down to Dow Jones's 5%. Mitchell Energy, natch, brought up the rear with a minus 11%. So what? In investing, if enough stars shine, a few can flicker. The management skills that make the high-return companies excel, in the market and every day, cannot readily be generalized. ''If any specific way of approaching problems is common practice,'' says Claiborne's Art Ortenberg, ''it is by definition incorrect.'' Well, says his wife, she does think ! there's something that matters to most businesses: ''Keep your eye on the product. That was all-important to me.'' The philosophies of both are visible in their decision not to own any manufacturing plants, but instead to contract work out. In earlier careers, each had seen the rigidities built into certain textile businesses, which cared more about keeping their mills going than they did about consumer preferences. Says Ortenberg: ''When you see something like that, you realize that small and flexible is where it's at, and large and repetitive is sheer disaster.'' Nevertheless, Claiborne's executives -- very much including the woman with her name on the door -- have worked with their manufacturers, most of them in the Far East, just as closely as if they owned them. The goal, the boss says, has always been quality. AT COMMERCE Clearing House, runner-up on the stars list, quality is called service. When Congress suddenly passed a new tax law last November, CCH exploded into action, working on Thanksgiving Day and straight through until Christmas to get the law's particulars into its 1988 tax reports. ''We did it, and none of our competitors did,'' proudly says Richard Merrill, CCH's president, which no doubt helps explain why CCH is the runaway leader in this business. Anheuser-Busch and Kellogg have much in common. Both are capital intensive, which most of the stars are not. Both dominate their markets and protect their brands with heavy advertising. And both are apostles of quality. Indeed, the brewer's chairman, August A. Busch III, 51, is so fervent about taste and ''drinkability'' that he brags about being the industry's high-cost producer. His business makes up for the money it lavishes on brewing, he says, by being super-efficient elsewhere -- for example, in the manufacture of cans. Busch is also thinking of vertically integrating still further, into bottle manufacture, which is a business overrun today by leveraged-buyout companies, such as Owens-Illinois. Busch doesn't like the prices being asked for bottles. ''Somebody has to pay the banker,'' says Busch, and he'd rather not be the one. Busch says his unions are his ''partners'' in striving for quality, and Daniel J. Krumm, 62, chairman of Maytag, home of the Lonely Repairman, makes the same point: ''Our unions have never resisted when we wanted to do something that would improve quality.'' But Maytag has had difficulties, he says, in trying to transplant its quality culture to stovemaker Magic Chef, acquired in 1986. Cost control is another banner that many of the stars wave. The champ in this area when FORTUNE did its list five years ago was American Home Products, a widely diversified company that makes such products as Inderal, Advil, and Chef Boyardee spaghetti. Traditionally the executive lifestyle has been spartan. Miraculous to report, American Home has recently bought a plane -- for convenience and security reasons, says Chairman John R. Stafford, 51. But let it not be thought that discipline has buckled. One Wall Street analyst recalls asking Stafford admiringly some time ago how he kept profits moving ahead so steadily. ''Well,'' said Stafford, ''if a manager goes over budget, I call him in for lunch.'' Pause. ''No one gets invited to lunch twice.'' American Home's insistence on ever-higher profits may help explain a financial disaster that has befallen that company and two other stars, Abbott Laboratories and Bristol-Myers. Those two dominate the infant-formula market, in which American Home is a distant No. 3. A government assistance program called WIC -- for Women, Infants, and Children -- is important to all these companies, accounting for about one-third of all cans of formula sold. Under the program, which is paid for by Washington but administered by the states, families at or near the poverty level are supplied vouchers to buy the product. Over the years, the states tried repeatedly to egg the companies into a bidding war for the WIC business. No one cracked. Then, in 1986, Tennessee finally got American Home, which was hungry for market share, to bid for the state's entire business. The price American Home agreed to take was 81 cents a can, vs. the $1.29 then prevailing. Two unsurprising things happened next: Oregon and other states leaped into this breach, all asking for bids, and Abbott and Bristol-Myers jumped to a defense of their market shares. By now, 41 states are exacting some kind of discount on the product. Lorraine Schwarz, a Salomon Brothers analyst, estimates that Abbott will average only 50 cents a can this year for its WIC sales. At that price, Abbott is selling below fully loaded cost and is engaged, says Robert Schoellhorn, the company's chairman, in a ''charity business.'' The three companies nevertheless continue to battle for sales -- and cry over their spilled milk. Analyst Schwarz believes that Abbott, for example, will earn only about $260 million, pretax, on infant formula this year, against the $360 million that could have been made had American Home not begun discounting. OPERATING MISTAKES of that magnitude are rare in star territory. But a raft of investment disappointments have made these prize performers acutely aware of their own limitations in running businesses other than those they grew up with. Jostens has been a better acquirer than most and remains on the hunt. It is even ready, when necessary, to pay the big prices that acquisitions command and that help create the disappointments. But, says Chairman H. William Lurton, 59, with feeling: ''You really don't know a business until you have to manage it.'' Jostens, for example, thinking that its knowledge of the education market could be extended broadly, bought some post-secondary schools that teach business skills. ''But,'' says Lurton, ''they were so different from what we knew. This was a service business that required intensive management, and there were a lot of legal requirements, and we couldn't figure out how to keep close track of what the schools were doing. One thing about us: If we feel uncomfortable for any reason, we'll swallow our pride and divest,'' which is what Jostens did. The differences between core businesses and add-ons are dramatically displayed at Philip Morris and UST. For both, tobacco is marvelously lucrative, partly because the retail buyer craves the product and tolerates price increases that other consumers might not. Would-be entrants into this industry are also virtually barred because tobacco products cannot be advertised on television. That prohibition, which fell on UST only in 1986, has nicely cut marketing costs, says UST's president, Nicholas A. Buoniconti, 48, the former Miami Dolphins linebacker. But, he says, thinking of smokeless tobacco lawsuits, ''All we've done is transfer the advertising budget to legal and corporate affairs.'' Sitting by, UST's communications vice president winces, no doubt wishing his boss had chosen in this instance not to communicate. Legal costs notwithstanding, UST's tobacco business earned 95%, pretax, on assets last year, a feat placing it second only to EG&G's nuclear wonder. A touch further down FORTUNE's segment list is Philip Morris's huge tobacco operation, with a return of 64% and so many dollars in profits -- $3.8 billion -- that it has some claim to being, in a financial if not a health sense, the best business in the country. Philip Morris, furthermore, has expertly clawed * its way up in this business, raising its U.S. market share in the last decade alone from 29% to 39%. But do these tobacco facts make Philip Morris and UST any good at running other kinds of business? Look at the bottom of the list. There you will see two UST operations: wine, on which it earned only 1%, and some miscellany -- mainly smoking pipes and cleaners -- that lost money. PHILIP MORRIS'S beer and food businesses are cellar dwellers also, of a monster kind. Included in the food segment are both General Foods and Kraft, in which Philip Morris has no less than $25 billion invested. Operating profits in 1988 were clobbered by a $348 million General Foods restructuring charge and include only a few weeks of Kraft's 1988 earnings. But even if both companies had contributed a full plate of profits, Philip Morris would have earned no better than 6%, pretax, on food. Treasury bills, at 6.4%, would have provided an edge. Anheuser-Busch might chortle at Philip Morris's experience with beer, in which it is a no-foam No. 2 with about 21% of the market, were it not for Busch's dismal encounter with food. It made less than 5% on that business in 1988, and that was a relatively good year for baker Campbell Taggart, Busch's main food operation. Jerry Ritter, Busch's chief financial officer, says the company overestimated its ability to transfer its skills to a different field. Says his boss: ''We sure learned this business the hard way.'' A few stars besides Jostens continue to look for acquisitions. But many have simply resorted to repurchasing their own stock, which amounts to buying into a business they know intimately and love. In the last few years Merck has spent $1.9 billion buying in 13% of its stock, and recently announced it might put as much as $1 billion more into the program. Other companies, such as Kellogg and Abbott, have even taken on debt to make repurchases. Roberto C. Goizueta, 57, chairman of Coca-Cola, is a true convert. A few years ago he was busy acquiring bottling companies and Columbia Pictures and telling the world how much sense that made. He has since reduced Coke's stake in these to under 50%, guzzled $2.3 billion of his own stock, and shown a thirst for more. Compared with Coke, Goizueta says, the bottlers and Columbia have lower returns and less-consistent cash flow. Buying Coke stock, he says, is simply ''a wiser use of capital.'' His conclusion agrees with a FORTUNE study (April 29, 1985), which showed that the typical company making significant repurchases because it thought its stock cheap had sharply outperformed the market. Stardom, alas, does not necessarily confer protection from hostile takeovers, and indeed may invite them. Five of the 21 look safe: Dow Jones, Washington Post, and Noxell are insulated by two classes of common stock, and Kellogg and Commerce Clearing House have large shareholders in their camp. Kellogg's is the Kellogg Foundation, whose stake is 34%, and CCH's is the Thorne family, at 56%. Another few members of the galaxy might seem untempting targets: EG&G, for example, because of its technology and its ties to the government. But takeover rumors have from time to time rumbled around Tambrands, Maytag, Jostens, and VF, among others. Today, VF's chairman, Lawrence Pugh, views his moderately leveraged capital structure uneasily. ''Having a great balance sheet,'' Pugh says, ''raises a red flag.'' Pugh, who acquired rival jeansmaker Blue Bell in 1986 and calls that deal ''phenomenal,'' would happily borrow to buy another apparel company. But prices, he says, are so horrendous as to jeopardize returns: ''And we are not going to leverage ourselves for the sole purpose of not being taken over.'' THE PROSPECT of a takeover may enhance VF in the eyes of investors. But then, the jeans market lacks the vitality it had a few years ago and VF's profits have been under some pressure. So there are questions as to what the company's return on equity will be in the future -- as there are also questions hanging over certain other stars. Maytag, for example, has recently paid a bundle to acquire Chicago Pacific and its appliance operation, Hoover. At least for now, Maytag cannot earn on its new investment the returns it has been earning on itself. At Commerce Clearing House and Deluxe, the uncertainties concern the technology wave, which is slowly rolling in on both businesses. CCH expects soon to be offering electronic versions of its tax reports, and Deluxe, though still printing billions of checks, has acquired companies that process electronic transfers of funds. Dow Jones's experience ought to reassure these companies. The company's flagship Wall Street Journal suffered a post-crash hangover last year, earning far less than usual. But profits of the company's information retrieval services rose nicely, vindicating the longstanding belief of Chairman Warren H. Phillips, 62, in the technology revolution. Tambrands has obviously got management problems to worry about, and millions ) of eyes will be watching as Claiborne's Chazen moves his act onto the fashion runway. EG&G is even rethinking those 152 businesses. Once almost totally autonomous, many are now getting a dose of centralization. Yes, says Chairman Kucharski, this reorganizing is a wrench for managers, but it is essential if EG&G is to run efficiently. So changes are in the works and risks abound. But the same could have been said five years ago, when FORTUNE was looking at its first batch of stars. Kellogg was then losing market share, and Merck was going through a dry spell in R&D. Both companies subsequently boomed -- and so did their stocks. The point, it seems, is that stars have a way of blazing all over again.

CHART: NOT AVAILABLE CREDIT: NO CREDIT CAPTION: A GALAXY OF FORTUNE 500 STARS To make this elite assembly, a company had to have averaged at least a 20% return on stockholders' equity over the past ten years and never have dipped below 15%.

CHART: NOT AVAILABLE CREDIT: NO CREDIT CAPTION:WHERE THE BEST BUSINESSES MAKE THE MOST -- AND THE LEAST This unique lineup shows what our 21 stars earned last year, pretax, on their ''identifiable assets'' in various businesses. Seven companies present their entire busi ness as one segment, and a few figures don't tell all. Commerce Clearing House's publishing business is more gemlike than it looks because its tax report subscribers supply interest-free capital by paying in advance. Ditto Washington Post's News week. But with national advertising weak, it took a restructuring charge for employee early retirements and an office move.