(FORTUNE Magazine) – Confounding expectations, America's largest companies tallied up a stunning 23.3% increase in profits in 1996--an extraordinary performance in the sixth year of a recovery. With the economy in the late stages of a marathon, the FORTUNE 500, impressively lean and muscular, is still running four-minute miles.

Not only did earnings sprint ahead in 1996; they also grew faster than revenues, which increased 8.3%. This uncommon--and ultimately unsustainable--phenomenon has been occurring for four straight years. That means corporate America, hell-bent on controlling costs, is still finding new ways to squeeze more profit from each dollar of sales. You have to look back all the way to the go-go years of the early Sixties to find a time when profits outgrew revenues for that long. Is it any wonder analysts are calling this the "earnings decade"?

Corporate profits are racing ahead at a quicker clip than just about any key economic measure, including GDP, industrial production, inflation, retail sales, exports, and personal income. "The divergence between the growth in profitability and the growth in everything else in the economy is just striking," marvels James Paulsen, chief investment officer at Norwest Investment Management in Minneapolis.

Helped by an almost magically favorable economic climate--with low interest rates and benign labor costs--the companies of the FORTUNE 500 have restructured, reengineered, refinanced, downsized, laid off, split up, and merged their way to prosperity. Says Richard Rippe, chief economist at Prudential Securities: "These companies have done a spectacular job of controlling their costs."

A deeper look into the 500 bears that out. Since 1991, the companies on this year's list have increased their median operating margin--an after-tax measure of profitability--from 3.79% to 5.6%, an improvement of nearly two full points, according to calculations done for FORTUNE by Zack's Investment Research. Rippe, who analyzes corporate profit numbers published by the Commerce Department, notes that operating margins for American businesses reached their highest level in 25 years during the third quarter of 1996.

An awesome performance, to be sure. But how long can companies raise profits at a double-digit pace without also expanding revenues at a similar rate? Don't businesses need to start selling more jet engines, more hamburgers, more software programs, and more telephone calls--to keep this earnings express rolling?

Consider: Of the 305 companies on our list that reported profit increases last year, a hefty 78% grew earnings faster than revenues. "I don't view that as a positive sign," worries Stephen Roach, chief economist at Morgan Stanley. "Corporate America has gotten very good at focusing on operational effectiveness, but in doing that, it has dropped the ball on sustainable growth." Joel Friedman, a managing partner of Andersen Consulting's strategic services group, concurs: "Reengineering got rid of the bloat. That's fine as far as it goes, but now it's done. What do you do for an encore?"

Don't count on price increases to keep the profits coming. Whatever the premonitions of Alan Greenspan, for most companies, price inflation remains ruthlessly in check. Any company trying to raise prices is now likely to face the wrath not only of customers but also of the Fed. Says Martin Barnes, an economist with the Bank Credit Analyst Research Group in Montreal: "The Fed has raised interest rates expressly because it doesn't want companies to raise prices. If companies raise prices, the Fed will raise interest rates more, so profit margins will get squeezed. The Fed is practically guaranteeing that profits won't go up." The absence of pricing power is glaringly apparent in the so-called core consumer price index, which excludes volatile changes in food and fuel prices, and which rose in February at a year-over-year rate of just 2.5%.

Even the 500's giants are powerless to resist that trend. McDonald's (no. 128) is moving like a juggernaut overseas, but the burger chain plans to drastically drop the price of its Big Mac--to a mere 55 cents--at home. Boeing (no. 36) has a backlog of orders that will keep its factories humming through 2006. But management nonetheless aims to drive down the cost of building a jetliner to 1992 levels by 1998. Explains Robert Dryden, executive vice president of commercial airplane production: "Every competition we have for new business is tougher than the one that came before. The prices we can charge are falling every day."

Compaq (no. 60), the world's leading producer of personal computers, added $3 billion to its cash flow last year, not by raising the price of its PCs but by streamlining unglamorous operations like accounts receivable. Credit-card giant MBNA (No. 411), the bank with the highest return on equity in 1996, has improved its expenses-to-revenue margin by 15% in the past two years, partly by deploying "data mining" computers that home in on their most profitable customers.

Such moves have made companies more competitive, but the process has been neither easy nor voluntary. Maureen Allyn, chief economist at Scudder Stevens & Clark, argues that companies had to cut costs because they couldn't raise prices. Says she: "Many companies have had to restructure not for higher profit margins but for survival."

A rare alignment of favorable factors has helped companies keep profits rolling in a time of diminished pricing power. You probably need an astrologer, not an economist, to explain how some of the most basic costs of doing business all happened to decline or flatten out at the same time. Look at the list of savings that have basically been handed to managers on a platter: low interest rates, modest wage increases, decelerating employee health care costs, a dramatic fall in the cost of computing power, and over much of the Nineties, an export-enhancing descent in the value of the dollar (see charts, last page of story).

Among these gift horses, it is the decline in interest rates that has done the most to foster the FORTUNE 500's bottom-line bonanza. The prime rate, which stood at 11% in 1989, tumbled to a low of 6% in 1993 before it began inching up again. Managers seized on the slide in rates to drastically overhaul their balance sheets. Using Commerce Department figures, Allyn calculates that the dramatic fall in corporate debt service as a percentage of sales has accounted for virtually all the improvement in profit margins in the Nineties.

But now, just as cost cutting may be getting harder, these beneficent breaks appear to be slipping away. For one, the great refinancing party of the mid-Nineties is over. The Federal Reserve officially blew out the candles in March when it raised the Federal funds rates for the first time in two years. The current pace of economic growth suggests more rate hikes could come. And money isn't the only thing getting more expensive. Wages, which were remarkably docile for most of the Nineties, have begun to rise more quickly--up 4% over the past year. Some high-tech companies, including Compaq, are having trouble finding qualified employees--at any wage.

Health care inflation, well down from its double-digit increases of the early nineties, is perking up again. The dollar has turned north, jeopardizing the foreign sales of FORTUNE 500 companies. And consumer debt has risen to worrisome levels, which could make domestic sales harder to come by. Result: Security analysts have begun scaling back their earnings forecasts for the year ahead.

Signs of slippage, we now know, began appearing late last year. The Commerce Department recently reported that corporate profits fell 1.1% from the third quarter to the fourth quarter in 1996. That's not a cataclysmic drop, to be sure, but it's another reminder that tougher times could lie ahead. Forward-thinking CEOs know that in their bones, and they're planning for it.

Take Boeing, which reported a 179% increase in profits last year, the 29th-biggest gain on the FORTUNE 500. The Seattle company recently signed a $6.7 billion deal to supply one airline, Delta, with 106 jets over the next ten years.

Last year Boeing agreed to merge with McDonnell Douglas (No. 87), a move that will give it a major presence in the defense business and should provide a counterweight to the more volatile commercial aircraft market. At the same time, the company has undertaken a nose-to-tail overhaul of its production processes, revamping some procedures so entrenched that they date back to the construction of the B-17 bomber in World War II.

Boeing plans to replace 400 independent computer systems with just four software programs, which will manage aircraft production from the parts suppliers to the final customer. A team of Japanese consultants, well versed in Toyota's legendary production methods, is helping Boeing improve productivity. One small example: workers can now set up a 250-ton hot-forming press in just 100 seconds--a process that used to take nearly an hour. Says Boeing production manager Robert Dryden: "We're radically changing the way we do business. If we didn't, we would be in big trouble with the price of our airplanes."

McDonald's knows all about the perils of setting prices too high. The restaurant chain didn't exactly have a bad year in 1996. It reported its 31st consecutive year of record sales and profits, and its 9% return on assets was the best in the food services industry. But McDonald's earnings rose only 10%, barely ahead of revenues, which increased 9%, and its stock price went up a paltry 0.6% in 1996.

McDonald's non-U.S. operations--the company has outlets in 100 countries--were solidly profitable. The problem was the home market, where rivals like Wendy's and Burger King have been nibbling away at its market share. Concedes chief financial officer Michael Conley: "The U.S. is a highly competitive environment. Our cost reductions over the past few years have been significant, but not significant enough to raise our margins."

McDonald's wants to boost those margins not by raising prices but by cutting them--sharply. For the plan to work, two things have to happen: a whole lot of customers have to buy a whole bunch of additional burgers, and the company has to keep trimming costs. It plans to save $750 million over the next two years by taking such mundane steps as revamping the routes of the trucks that deliver its french fries.

Compaq is finding new ways to prosper in an industry in which declining prices are routine. The Houston company increased its profits 66.4% last year and notched a total return to investors of 54.9%, the 50th best on the list. Chief executive Eckhard Pfeiffer, a famously fast driver, has steered Compaq up the value chain into an array of products with potentially fatter profit margins--including workstations, servers, and networking equipment--with the hope of positioning the company as a provider of systems, not just individual pieces of hardware.

At the same time, chief financial officer Earl Mason has lifted Compaq's return on invested capital from 21% to 59%. Just by making sure customers pay their bills on time and by stopping Compaq from paying its own bills unnecessarily early, the CFO managed to generate an extra $2 billion in annual cash flow in 1996. Sales and finance people achieved the improvements by using computers--made by Compaq, naturally--that flashed the relevant information in real time.

Mason isn't worried about rising interest rates. With a $4 billion pile of cash and just $300 million in debt, why should he be? Nor is he concerned about escalating labor costs. Compaq's already sky-high productivity--$960,000 in revenues per employee per year--is climbing higher still. What Mason does fret about is a labor market so tight that Compaq is having trouble hiring the experienced people it needs to grow. Says he: "Our single greatest problem is making sure we have enough management bandwidth at this company. That's what keeps us up at night."

What Compaq and most of its computer industry peers have been able to count on in recent years is an extra-large slice of the capital-spending pie. With little room to maneuver on the price front, companies are betting big on technology. Last year they spent a record 42% of their capital equipment budgets on computers and software. More than ever, U.S. businesses are using computers not just to build things more efficiently or process transactions more rapidly, but to invent totally new ways of delivering products and services.

MBNA, a bank that has no retail branches, is a pioneer in the marketing of credit cards to affinity groups--everyone from the Stanford University alumni association to fans of the Chicago Bulls. Profits at the Wilmington, Delaware, bank rose 34% last year, and its 28% return on equity was the best in the industry. MBNA's expenses as a proportion of outstanding loans--a standard measure of productivity in banking--have fallen from 6.3% to 5.2% in the past two years.

MBNA, one of the first credit-card banks to offer 24-hour telephone assistance to customers, doesn't try to be the low-cost producer. It boosts efficiency by using proprietary software to target its ideal customers--solid citizens who pay their monthly credit card bills regularly but not necessarily in full. MBNA also uses its computer systems to customize interest rates and payment terms for each of its 4,500 affinity groups.

Says the chairman and chief executive Alfred Lerner: "One of the reasons we have been able to grow so fast is that we have the computer technology to manage individual groups, to select different interest rates, to measure profitability group by group."

So begins the next phase of competition--to use the $212.8 billion annual investment in technology to better serve the market, to reshape business, and to outsmart rivals. In short, to find new ways to keep earnings growing.

To help you identify companies that are doing just that, this year's 500 once again cuts through data in a variety of ways. To see who's succeeding, look at our ranks of the biggest profit increases (page F-27) or compare the returns on equity of all health care companies, the profit margins of all computer outfits, or the return on assets of commercial banks (F-44). The 1,000 companies reviewed in this issue provide a wealth of performance information. We hope you profit from it.

REPORTER ASSOCIATES Jeanne C. Lee and Eileen P. Gunn