If you want to own a stock forever, you don’t necessarily want the fastest growing stock. Sometimes reliable growth is just as important. In fact, if you want a stock to own forever, its ability to steadily compound its capital is even more important.
You want growth, but sustainable growth
When a company deploys precious capital, you want to know that it uses its resources to create value. For example, if your company invests $1 and it earns $0.15 over the year, you will end up with $1.15.
If you invest $1.15 at the same rate of return (15%), it would be worth $1.3225 the next year. Invest $1.3225 again at that rate of return and it would become $1.52. You end up with 50% more capital by the end of year three.
Look for high quality compounders for the long term
The point is you don’t want growth for the sake of growth. You want to own stocks that thoughtfully and consistently use their resources to compound shareholder value.
Over the long run, stocks follow the cash and earnings that compound in a business. If you want big winners over long periods, follow the compounding. Here are three “growth” stocks that could continue to create significant value over the years ahead.
A forever software stock
Constellation Software (TSX:CSU) has been one of Canada’s greatest compounders of value. Its stock is up nearly 1,800% over the past decade! It has almost perfected the formula for compounding.
It buys niche software businesses at bargain prices, uses best practices to maximize cash flows, reaps the cash flow, and invests into more businesses. Since the software business is very cautious about not overpaying, it tends to earn a high 20%-plus internal rate of return on its acquisitions.
The company owns around 800 businesses today. However, it has a database of opportunities that is closer to 100,000 businesses. The forward opportunity remains substantial.
Its stock has soared over the past six months, so it is not a bargain today. However, even if it (or its recent spin-offs) can continue to smartly grow by a mid-teens rate, long-term shareholders should do quite well.
A freight stock with a great future
TFI International (TSX:TFII) has a similar strategy, but in a more focused industry. It has grown to become the largest freight, trucking, and logistics carrier in Canada and a major player in the U.S.
TFI stock is up 329% over the past five years. The company has done this by consolidating over 180 small and midsized shipping operators across Canada and the States.
The company has a decentralized management platform where operating managers are responsible for managing profitable, efficient businesses. TFI has a long-term CEO who has focused on maximizing returns on invested capital.
In December, it announced its largest acquisition to date. This could prime it to spin-out its truckload business from its less-than-truckload, courier, and logistics businesses (that tend to fetch higher valuations). That could result in a major stock rerating over the coming years.
An industrial business with great capital allocation skills
If you take a quick look, TerraVest Industries (TSX:TVK) wouldn’t seem like a growth stock. It operates a mix of boring industrial businesses. These are focused on transportation, heating products, gas/chemical storage, and oil/gas services. These are not typically associated with growth industries.
However, the key is the company’s capital allocation. It buys cheap businesses, uses operating expertise to maximize cash flows, and reinvests the cash into more businesses. It tends to have returns on invested capital in the low-to-mid teens.
TVK stock is up 366% over the past five years. Despite the increase, its valuation remains reasonable. It has a young management team and highly invested board. It has all the makings of a long-term compounding stock.
