3 signs a company is a secret growth star

I am a firm believer in buying great businesses today which will grow their cashflow and earnings for years and years to come.

It sounds cliché, but it really is one of the simplest ways to approach the idea of investing and it’s an easy way to cut out the noise and conjecture which can rob us of our focus (and our sanity). There are two parts to this process:

1. Find a business with a high probability of growing for years to come; and

2. Buy the business for an attractive price

The first part sounds easy, but how do we know a company is going to grow, and keep growing? Here are a three signs to look for which signal a strong probability of growth:

1. Look for a growing market

It’s a lot easier for companies to grow when there is increasing demand for what they sell. A company will need a plan to capture as much of the growing market as possible, but growth comes more easily and at lower cost than if demand is stagnant.

ResMed Inc. (CHESS) (ASX: RMD) is an example of a company selling into a growing market for healthcare products around the world. The growth is being driven by aging populations and an increase in healthcare spending. For the most recent quarter to 31 March 2016, ResMed reported revenue growth of 9% in constant currency terms.

2. Look for companies with a history of growth

In mature markets where growth is harder to come by, companies with a history of growth are likely to have identified successful  strategies or traits that they can continue to leverage. These are often based on competitive advantages, perhaps selling a superior product, service, or brand which will help to win market share off rivals.

Despite rigorous competition in the fast food space, Domino’s Pizza Enterprises Ltd. (ASX: DMP) excels by selling tasty pizza at competitive prices. The company also has a highly efficient production model which means it is at the front of mind when customers are making purchasing decisions late at night, or after a few beers.

3. Look for repeat customers

Repeat customers are usually a sign of some other competitive advantage, like high switching costs or brand loyalty.

The repeat business helps to compound cash flows and means that the return from winning one customer is far higher than just the customer’s initial purchase. Many software service companies like XERO FPO NZX (ASX: XRO) have measures of Annualised Recurring Revenue, while companies which can create ‘network’ advantages for users like Trade Me Group Ltd (ASX: TME) can also command aggressive market positions and repeat business.

Looking out for these three growth signs and buying the underlying businesses at attractive valuations is a smart strategy towards investment success.

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Motley Fool contributor Regan Pearson owns shares of Xero. The Motley Fool Australia owns shares of Xero. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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