...And the Award Goes to Apple!

A fall from grace is both difficult to watch and morbidly fascinating. Whether the subject is a person of high regard or a greatly respected company, often it is impossible to look the other way.

Such is the case with Johnson & Johnson in Barron's latest ranking, The World's Most Respected Companies. Few firms, with the possible exception of banks, have fallen harder in the eyes of our respondents since our survey of professional money managers was launched seven years ago. J&J (ticker: JNJ) has always ranked No. 1 or No. 2 in garnering respect from investors—until this year, that is. After struggling with quality-control issues, the New Brunswick, N.J.-based health-care giant has tumbled all the way to No. 25 among the world's 100 largest public companies, hanging on to the list's first quartile by its bloodied fingernails.

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JNJ's nosedive contrasts sharply with Apple's (AAPL) staying power, as the fabled inventor of the iPod, iPhone and iPad tops our annual ranking for the second consecutive year. What's more, the bouquet of accolades thrown at Apple might make even Steve Jobs blush. America's money managers praise the company he built as "visionary," "courageous," "innovative" and possessed of a "strong corporate culture," which has fostered "consistent execution." No matter that some say Wall Street's near-religious devotion to Apple, coupled with the stock's 53% rally last year, could be setting the company and its shares up for a fall. For now, Apple reigns supreme in commanding investors' respect.

Just as some companies fall out of favor, others, like Amazon.com (AMZN) gain greater esteem from investors. The online retailer is No. 2 this year, up from No. 10 in 2010. Berkshire Hathaway (BRKA), a perennial at the pinnacle, is No. 3, up from No. 5, in a vote of confidence for founder Warren Buffett's leadership. IBM (IBM) maintains its fourth-place status, while McDonald's (MCD) cracks the top five for the first time ever, edging up from No. 7 in a vote of confidence for the company's management and strategy. Even burgers, well done, can be as sexy as iPads.

EACH YEAR Barron's surveys professional money managers about their views of the world's 100 largest companies, based on total stock-market capitalization at year end, as determined by Dow Jones Indexes. This year's survey, conducted with the help of Beta Research in Syosset, N.Y., elicited responses from 92 investors across the country, ranging from proprietors of small advisory firms to the chief investment officers of money-management giants overseeing billions of dollars.

Participants were asked to select one of four statements reflecting their view of each company: Highly Respect, Respect, Respect Somewhat or Don't Respect. A point value was assigned to each response, with the highest accorded to Highly Respect, and a mean score was tabulated for each company. In the case of ties, the higher ranking went to the company with the most Highly Respect votes. The managers also were asked to rank the factors they consider most important in determining respect for corporations, and were invited to contribute comments on individual companies.

BP (BP), the British oil producer, fell more places than J&J, but already had been held in only middling regard. No. 47 in 2010, it slid to No. 95, where it rubs elbows with governance-challenged Russian companies, not to mention Citigroup (C) and Bank of America (BAC), ranked No. 96 and No. 97, respectively.

Procter & Gamble (PG) consistently has ranked among the top five in commanding respect, but not this year; it clocks in at No. 10, down from No. 3. Investors may be disappointed that its shares rose only 6% last year, and concerned that P&G's higher-priced products could be less competitive in a post-recession world.

What Inspires Respect?

A sound business strategy trumps management for our respondents. "Even the best CEO can't make a huge success out of a flawed business strategy," says Harbor Advisory's Jack DeGan.

Toyota Motor (TM) also lost face, plummeting to No. 47 from last year's No. 6, as investors reacted to the company's recalls of various models for mechanical problems in 2009-10. And Goldman Sachs (GS), the global investment bank that appeared on the list for the first time last year, promptly fell this year to No. 66 from No. 30, a remarkable drop for a company considered uniquely successful by investors around the world just a few short years ago.

Moving up sharply on in our survey are companies such as No. 7-ranked 3M (MMM); No. 21-ranked Siemens (SI), and Daimler (DDAIFF), the German automotive leader, now No. 30. The French luxury-goods conglomerate LVMH Moët Hennessy Louis Vuitton (MC.France) is ranked No. 32, up from No. 52, while Britain's Vodafone (VOD) is No. 36, a long way up from last year's No. 65.

Each of these companies won more respect for different reasons, but the collective advance of the four European outfits speaks to another of this year's themes: a 50% increase, to 15, in the number of foreign companies among the top 40 names on the list.

WITH THE EXCEPTION of BP, our cellar dwellers aren't new to their lowly position. Russian companies consistently have been dissed by U.S. investors, and rightly so, for poor governance, corruption and Russia's disregard of the rule of law. Gazprom (GAZP.Russia), the energy-exploration giant, is No. 100, a short but ignominious drop from last year's No. 99. Its replacement in the penultimate position is Sberbank (SBER03.Russia), down from No. 97, while Rosneft (ROSN.Russia), another energy producer, stays at No. 98.

What determines respect? "Sound business strategy" gets the most votes this year, from 32% of money managers, eclipsing "strong management," which was most important to 28% of respondents but last year ranked No. 1. That is a "healthy and important change," says Jack De Gan, chief investment officer at Harbor Advisory in Portsmouth, N.H. "Even the best CEO can't make a huge success out of a flawed business strategy."

De Gan thinks former Fidelity fund manager Peter Lynch said it best when criticizing the cult of star CEOs: Go for a business that any idiot can run, because sooner or later any idiot probably is going to be running it.

Interestingly, only 12% of money managers now consider "ethical business practices" the first determinant of respect, down from 20% last year. Could it be that memories of fraudulent behavior, financial shenanigans and other lapses in ethics are fading right along with memories of the credit crunch, bear market and Great Recession of 2008-09?

For Lloyd Khaner of New York's Khaner Capital, management still is tops. "Management is the single most important factor" in determining a company's direction and success, he says. "If I take a torpedo because of management [I've invested in], there's no one to blame but myself."

Jack Oliver, head of money manager RBO in St. Helena, Calif., agrees. "Strong management will drive all those other components. It will be ethical and innovative…. It's an intangible asset on the balance sheet."

SOME MONEY MANAGERS cite respect as the first cut in their investment process. But others say respect is the result of strong investment performance, which reflects a multitude of smart decisions made by management and employees. Respected companies treat their shareholders, customers and employees well, and companies whose shares go up seem to garner ever greater respect. "You'll get respect if your stock is up," says Paul Jackson of Paul Jackson & Associates in Auburndale, Mass. "It often comes down to stock price."

For Apple, it is hard to know where respect ends and blind adulation begins. In the past five years Apple has shown "an ability to execute and have the pulse of the world consumer," says Seth Shalov, a portfolio manager at MAI Wealth Advisors in Cleveland.

Apple has redefined the consumer-electronics market, inventing must-have telecommunications gear and pocketing additional revenue from the sale of iPhone and iPad applications, or apps. "Steve Jobs has revived a culture that emphasizes vision and is highly innovative," says Tom Weary of Pacific Income Advisers in Santa Monica, Calif.

How Apple fares with Jobs on a medical leave of indeterminate duration is another matter. Although the company has a deep bench, the law of large numbers may begin to work against it. With a huge market capitalization of $328 billion, the company might languish a while without Jobs, Shalov says.

AMAZON.COM IS ANOTHER COMPANY that has taken full advantage of the Internet, becoming the world's largest online retailer. Indeed, it is one of the few healthy survivors of the dot-com boom of a decade ago. Dismissed as a fad in that bubble era, even by this publication, Amazon has gone on to generate more than $34 billion in annual revenue and command a market value of nearly $84 billion.

"It is very profitable and always investing for a better consumer experience…adding [retail] categories all the time," says Jim O'Donnell at San Francisco-based Forward Management. Amazon has a "phenomenal" core business and is going global, he adds.

"It surprises you on innovation, too," says Pacific Income's Weary.

As for Berkshire Hathaway, there is little to add about its consistently high ranking in our survey and many others. The company garners respect for its lengthy history of operating and investment successes, and that leads straight to the boss—the plainspoken, octogenarian, Cherry-Coke sipping Wall Street legend, Warren Buffett.

In the throes of the financial crisis, his investments in Goldman Sachs and General Electric (GE) helped stabilize both companies and give the financial markets a much-needed shot of confidence, notes George Mussalli, a money manager at PanAgora Asset Management in Boston. Buffett, he says, "is like the market's Good Housekeeping Seal of Approval."

For that and other reasons, Buffett's 13EEE-size investment shoes will be difficult to fill when the master steps down. "Can Berkshire survive after Buffett's exit?" asks David Hartzell, CEO of Cornell Capital Management in upstate New York. "Yes, but it won't be the same company. This is even more of a question than at Apple. Is Berkshire's bench enough to hold an oddball conglomerate together?"

Good question.

Institutional investors' abiding fondness for IBM suggests the company finally is achieving some lasting recognition for a once-controversial switch made years ago—to emphasize software and services over mainframes and other computers. Respect, hard won and long in the cultivating, doesn't always come from meeting quarterly earnings estimates or achieving other short-term goals that Wall Street demands, survey-takers noted.

With the Street focused on IBM's transformation and the then-controversial disposal of its legacy hardware business, the company didn't receive the credit it deserved for steady earnings growth without major profit disappointments. "It is a great example of a company that has moved to services from hardware, adding value and longevity," says Peter Scholla, a partner at Global Investment Adviser in North Palm Beach, Fla.

AND THEN THERE ARE HAMBURGERS, lots and lots of them, made and sold by McDonald's, another belated recipient of much-deserved respect. The company's image on Main Street as the biggest fast-food chain in the world doesn't do it justice, according to our respondents. On Wall Street, McDonald's is viewed as a company that changed its spots for the better back in 2002-03, moving away from a single-minded focus on unit growth to a more mature approach that balances growth with the return of cash to shareholders. Much as investors like McDonald's appetizing 3.3% dividend yield, they also appreciate that it has responded effectively to changes in society's eating and drinking habits.

"What business is more up, down and risky than the restaurant business?" asks Cornell Capital's Hartzell, a big fan of the stock. "People think of McDonald's as a burger maker, but they've got specialty coffees, salads and sundaes now"— a testament to the company's ability to reinvent itself.

That brings us to companies such as J&J and Toyota, which must reinvent themselves quickly, or at least make some big changes to get back into investors' good graces.

The litany of Johnson & Johnson problems that have exploded into the news in the past 18 months is too lengthy to recount, but here are a few: Just last month, a Texas federal jury ordered the company to pay $482 million in patent-infringement damages. J&J's once-pristine respect score also has been hurt by a string of product recalls at various subsidiaries, especially some that sell children's medicines and the company's flagship over-the-counter painkiller, Tylenol. When it comes to respect from investors, the message should be clear: Don't mess with kids' drugs.

Johnson & Johnson has pulled almost 47 million units of over-the-counter products such as Tylenol, Benadryl, Sinutab and Sudafed, due to quality-control problems. In last year's fourth quarter, the company took a painful $922 million charge, representing the impact of litigation settlements, product-liability expenses and costs associated with the recall of certain hip implants at DePuy, another subsidiary.

J&J has had to suspend or alter activities at several plants, which could affect this year's sales. It has acknowledged that consumer trust of its products "has truly been tested." In its annual report three years ago, the company said it would focus on execution. "That's not what they've done," says Marc Heilweil at Spectrum Advisory Services in Atlanta.

Johnson & Johnson and McDonald's are a study in contrasts, says Fla Lewis, a principal at Weybosset Research & Management in Providence, R.I. The fast-food chain has kept its eye on the ball and protected its brand, while "at J&J it seems to be one thing after another. They don't seem to be able to wrestle it down."

In an e-mail Friday in response to a query from Barron's, CEO Bill Weldon noted that, until the recent setbacks, the company had built a strong reputation in the past 125 years. And he added: "We are working diligently to overcome our recent problems to ensure only the highest-quality products reach our customers—the first step to earning back their trust and confidence."

One consolation for investors is that Johnson & Johnson's earnings have grown, even through the company's troubles. Earnings rose to $4.78 a share last year from $4.40 in 2009, even though revenue was basically flat at $61.6 billion. J&J also pays a dividend of $2.16 a share, for a yield of 3.5%.

IN MANY WAYS, our survey of investor respect is an accurate barometer of public perceptions about a number of big companies—and a warning to those in need of change. Take Toyota, another long-trusted maker of familiar products that also was rocked by a series of recalls beginning in late 2009. The Japanese company recalled about eight million vehicles amid allegations of defective floor mats and accelerator pedals.

Toyota was tarnished not only by the need for a recall but "the way they handled it," one money manager wrote. "They didn't address as quickly as they could have."

The timing was bad, a lost opportunity. "It was a perfect time to screw up, right when General Motors [GM] and Ford [F] were flat on their backs," quips Paul Jackson.

Yet the well of respect for Toyota hasn't run dry, as our respondents indicated the company would recover from its current woes. Just last Tuesday, for instance, an investigation by NASA engineers showed no link between electronic throttles and unintended acceleration in Toyota vehicles, something that should help the auto maker recover its reputation.

After several years in the doghouse, General Electric (GE) is one company beginning to see some daylight. The company rose in our ranking to No. 48 from No. 74 last year. Once the standard-bearer for American capitalism, GE was hurt when its highly leveraged finance unit hit an air pocket amid the financial crisis. The company had to run to Buffett for a major cash infusion.

Since then, GE's core industrial businesses have been on the upswing, and the company has reduced its reliance on GE Capital, its finance unit. It also sold off its 51% stake in the NBC Universal entertainment business. Despite the improvements, some investors still are calling for GE to be broken up.

GE epitomizes bureaucratic thinking, says John Campbell of Cornerstone Investment Partners in Atlanta. "It is hard to understand where the value is being created…by largely unrelated businesses," he says.

PanAgora's Mussalli agrees, noting the company's collection of businesses "perpetually underperform." The various divisions could do much better alone, and "a break-up could unlock value," he says.

Both money managers indicated they "don't respect" GE, although plenty of others now do.

THE DOGHOUSE, reputational and otherwise, is like an airport hotel: Companies move in and out, doing their best not to linger long. For U.S. and Russian banks, however, it is like a roach motel: They get in, but can't seem to get out.

At the recent World Economic Forum in Davos, Russian President Dmitry Medvedev expressly conceded that the country's problems hinder investment and vowed to improve the investment climate. That is a big job and won't happen overnight.

American banks such as Citigroup and Bank of America also are likely to forgo investors' respect for a while longer, given their dismal performance at the depths of the global financial crisis. "They took TARP [Troubled Asset Relief Program] money and their reputations disintegrated," says David Corbin, CEO of Corbin & Co. in Fort Worth, Texas. "In some cases there also was highly questionable behavior. Some had great legacies that have suffered."

The anger still smolders over the role of big banks in helping to foment and deepen the crisis. "The amount of arrogance [on the part of banks] towards the U.S. taxpayer is extraordinary," says James Vanasek of VN Capital Management in New York. "Citi was a weekend away from bankruptcy but kept on insisting nothing was wrong. And no one was punished at the top."

Some banks have done better than others, however. JPMorgan Chase (JPM), for example, jumped to No. 14 this year from No. 21, mainly because of the respect accorded its popular CEO, Jamie Dimon. "The Bear Stearns merger was thrust upon him, but he made sure it wasn't going to hurt his company," says Thomas Goldsmith of Flagship Capital in Media, Pa., "He's stubbed his toe from time to time but learned from it."

BECAUSE OUR RANKING COVERS only the 100 largest public companies in the world, changes in share price and market capitalization determine which companies are on the list and which are excluded. This year 11 new names joined the ranking, replacing companies whose relative market value shrank in 2010.

The largest company in the world, No. 11-ranked Exxon Mobil (XOM), had a market cap of $368.2 billion as of Dec. 27, up 14% from a year earlier. The smallest on the list, Germany's E.ON (EONGY), had a market cap of $60.2 billion. Visa (V) didn't make the cut this year, but Colombia's state-run oil company Ecopetrol (EC) did. It ranked No. 93.

In 2010 the average mean score rose sharply, to 2.25 from a lowly 1.87. This year it fell slightly, to 2.12. Among the 89 companies included in both years' surveys, just 33 saw their mean scores rise in 2011, compared with 59 in 2010.

After the past few years of Ponzi schemes and other investment frauds, financial malfeasance and just plain bad execution, the concept of corporate respect arguably is more relevant than ever. That should be a wake-up call to all the companies whose reputations were dented by the financial crisis and other crises, both external and of their own making.

It is a cliché to say that respect is hard to earn but easy to lose. Yet that doesn't detract from its importance for these companies, and all companies. When will J&J, Toyota and even Citi be welcomed back into the market's good graces? Next year's Most Respected survey can't come fast enough. 

E-mail: editors@barrons.com