The Importance of Sustained Revenue Growth
(check out Puru Saxena’s thread on the topic here)
Holding long-term compounders is typically how investors beat the market. And how do they find long-term compounders? By identifying stocks with the potential for sustained high-levels of revenue (or cash flow, or earnings) growth.
This metric is important because it allows individual investors like myself to counteract the efficient market hypothesis (EMH). Over short timespans, markets are basically efficient, making it difficult for anyone to get an edge. But over long periods (3-5+ years) the EMH goes out the window (EMH is based on current information, and thus does not apply over a long time period*). Individual investors are also helped by the vast majority of hedge and mutual funds, who get a lot of pressure from investors after one or two bad years.
But back to the original topic. Potential for sustained sales growth is near the top of my investing checklist because it is almost a necessity for a fairly valued stock to outperform its index. It’s all about identifying what is not already priced into the shares, which is easier to do the farther you look into the future. Now, the other side of the coin is, the farther you look into the future, the more unpredictable things become. That is why I try to find stocks with long-term tailwinds and sustainable advantages at a reasonable price and hold them forever.
Let’s look at a few stocks I own and what will happen to them if they can produce high sales growth over the next five years.
An easy one for everyone to identify with. Right now they have a P/S of 3.77, annual sales of $6.8 billion, and revenue growth of 28%. If they average 25% sales growth and command a sales ratio of 2.5 in five years, they will have a market cap of $51.9 billion compared to $27.2 billion today. That is an average rate of return of 13.79% with significant multiple compression.
Yext (learn about them here) has a market cap of $1.68 billion and is growing sales at 30% as of its latest quarter. It has a P/S ratio of 6 (higher gross margins than Spotify gives them that luxury). If I believe they can sustain 20% growth and will have a P/S of 5 in five years, they will have a market cap of $3.7 billion in 2025. That is an average annual return of 17% over that timespan.
JD.com is a Chinese e-commerce company. They have a market cap of $55.9 billion, a sales ratio of 0.73, and revenue growth of 28.7%. If they can average 15% sales growth and raise their sales ratio to one (I outline some reasons why they can here) they could have a market cap of $154 billion in 2025. That is an average return of 22.5% (likely higher because of the riskier Chinese market).
My favorite stock. Square has a market cap of $27.7 billion, a sales ratio of 6.4, and had 44% sales growth as of the latest quarter. An average of 30% sales growth and a P/S of 5 at the end of five years would give them a market cap of $84.8 billion. That is an average rate of return of 25% over that time period.
To be fair, you can make up these revenue projections for any stock. None of what I predicted is set in stone and is by no means certain. If there was 100% certainty of it happening, the stock price would already reflect that, and investing would be a useless endeavor.
That being said, I believe with these stocks, there is a high chance of these scenarios coming true. That is why I’m invested in them, and why I believe they can outperform over the long-term.
Disclosure: The author is not a financial advisor, and may have an interest in the companies discussed
*I hope I’m not speaking completely out of my ass here.