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The power of compounding is a well-established concept, however its potential is often underestimated.

  • 01 April 2016 (5 min read)

We have previously examined the power of compounding growth and how the concept can be observed in dynamic growth companies within equity markets. In this article we outline some of the key characteristics that help us identify companies that are likely to deliver positive earnings growth over the long term.

It is important to remember that successful investments in growth stocks require an appropriate time horizon. We suggest an investment horizon of at least three to five years as this improves the chances of the company fundamentals being reflected in its valuation.

Therefore, when searching for high quality growth companies, what do we look for? We can summarise the key attributes as follows:

  • high quality management team

  • strategic positioning in a growing industry

  • healthy cash-backed earnings growth, facilitating dividend growth and corporate investment

  • strong balance sheet

  • sustainable profit margins and business model

Case Study

A good example is RPC Group, a plastics products specialist with a broad customer base, including many household names, such as Garnier Mineral and Champneys.

RPC has consistently delivered1 on the key criteria mentioned above. The company is positioned in an industry that is currently benefiting from structural growth. Advances in technology mean rigid plastics are replacing more traditional (expensive and heavier) packaging such as glass and metal. Furthermore, the firm is maximising its potential within this growth sector through service and innovation. For example, they know from their clients in the cosmetics and personal care space that a large proportion of a product’s success is actually attributed to the look, feel and quality of the packaging, rather than purely its contents. Consequently, strong relationships and collaborative efforts have enabled them to develop innovative design solutions, providing additional avenues of
growth. Overseeing these activities is what we believe is a strong – and shareholder friendly – management team. By exercising financial discipline the company has delivered

consistent dividend growth of 16.3% (YoY)2 , supported by strong growth in earnings (19.5% EPS growth (YoY)2 ) and a successful campaign of acquisitions in the highly fragmented packaging market. The ability of management to strike the appropriate balance between rewarding equity holders and re-investing in the business and new opportunities has contributed to an impressive share price total return of 333%3 over five years.

We believe RPC has expertly applied the criteria required to be a successful growth company and investors have been reaping the rewards. Fortunately, there is a rich pool of dynamic companies in the UK that are harnessing the benefits of profit growth. In many cases, they have sound business models as well as the managerial and financial strength to maximise future opportunities. Focusing on these key areas should help ensure that they continue to demonstrate sustainable turnover growth which, together with the potential of expanding margins, should translate into strong returns for equity investors over the longer term.

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