As the world is adjusting to a new normal brought about by the COVID-19 pandemic, growth remains a hot buzzword for investors.
While some industries such as airlines and tourism are reeling a sharp plunge in demand, others have benefitted from the onset of the pandemic.
Sectors such as cloud computing and financial services have enjoyed booming sales as more people go online.
With hospitals around the world running low on medical supplies, companies manufacturing rubber gloves have reported sales orders at multi-year highs.
As investors, we need to keep an eye out for companies that do well not just because of this wave of new demand.
Businesses experiencing strong growth should ensure that they have long-term catalysts and tailwinds that can help them to sustain this growth.
Otherwise, investors could see the growth fizzling out in the twinkling of an eye.
What are the signs that investors should look for when it comes to growth? We present three tell-tale signs that a stock has excellent growth prospects.
- Rising net margins
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The first indicator is to look at both gross and net margins.
Gross margin is an indication of how well a business can price its products or services.
If gross margin increases over time, it means that a company can price its products at a premium and that customers are willing to pay for its products.
Net margin, on the other hand, measures how efficiently a business manages its expenses.
Increasing net margins indicate that a business may enjoy operating leverage as costs rise much less than revenue.
It may also mean that management is keeping a lid on rising costs and are seeking economies of scale to ensure costs are manageable.
The above table shows the gross and net margin profile for AEM Holdings Ltd (SGX: AWX).
AEM offers intelligent system test and handling solutions and serves customers in the semiconductor and electronic companies that deal with artificial intelligence, 5G and advanced computing.
The group’s gross margin has increased from 16.9% in the fiscal year 2016 to 25.8% in the trailing 12-month period of the fiscal year 2020.
The rise in gross margins portends well for the company as it demonstrates the company’s strong pricing power as its products are highly sought after.
Net margin has tripled from just 6.6% back in 2016 to 19.2% as the group enjoys strong economies of scale along with a high proportion of its expenses being fixed costs.
The group has been growing its sales and net profit sharply as the electronics sector is booming with higher demand for cloud services and 5G networks, partly contributed by the pandemic.
- Surging revenue and gross profit
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There’s no better indicator of growth than to look at a company’s sales numbers.
For DocuSign (NASDAQ: DOCU), its growth has been nothing short of spectacular, and it shows in the table above.
DocuSign is a leading e-signature provider for companies and helps them to digitalise and process their agreements process with a cloud solution known as the Agreement Cloud.
If we look at the company’s growth from its fiscal year 2017 through to 2020, revenue has almost doubled from US$381.5 million to US$974 million.
Gross profit has also increased in tandem with revenue, from US$275.6 million to US$718.7 million over the same period.
As more businesses look to digitalise their agreement processes, DocuSign should see higher demand for its services, which will allow the company to grow its revenues even further.
- Consistently rising dividends
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The third sign of good growth potential is a company’s track record of increasing its dividends.
If a business can do so over a long period, it shows that the business has been growing its profits and cash flow steadily.
It also implies that management should be doing something right to enable the business to enjoy multiple years of growth.
For investors, it’s also a clear sign that management is willing to share the fruits of the company’s success by paying out increasing dividends.
For Starbucks (NASDAQ: SBUX), the table above shows the company’s track record in raising dividends.
The famous coffee chain, a staple in many malls and street corners and with a global presence, paid out just US$0.445 in its fiscal year 2013.
Since then, it has raised its annual dividend every single year without fail.
For the fiscal year 2020, Starbucks’ dividend stood at US$1.68 per share, up nearly four-fold from what it paid out seven years ago.
This works out to be a compound annual growth rate of around 21%.
Though the pandemic has temporarily shut some of Starbucks’ stores in the first half of this calendar year, the coffee giant has bounced back by modifying its stores to offer curbside pick-up and drive-through.
This crisis is likely to only slow the company down as it continues to open numerous stores around the world.
The three businesses above have what it takes to continue their sterling growth record.
These are the types of companies that you want to own so that you can compound your investment portfolio over years, or even decades.
The Smart Investor team used ShareInvestor WebPro to easily obtain the data needed for our analysis.
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Disclaimer: Royston Yang owns shares in Starbucks.