For investors aiming to build wealth, buying quality growth stocks and giving them time to develop is a powerful strategy. But the key is finding the right shares to buy.
The most important thing is finding companies that are going to be able to keep increasing their earnings for a long time. This isn’t easy, but there are some great examples that are worth considering.
Earnings growth
The most obvious way a business can grow its earnings is simply by selling more stuff. Assuming the company makes a profit on each unit it sells, increasing quantities should lead to higher earnings.
The second is by charging more for what it sells. The benefit of this is that simply raising prices allows a business to generate more revenue without the associated costs, resulting in wider margins.
The final approach is by cutting costs. Even if a business still sells the same volume of stuff at the same price, doing so at a lower cost can result in increased net income.
Different companies are able to do these things to different extents. But the key to finding quality growth stocks is identifying which firms will be able to do this over the long term.
Experian
I think Experian (LSE:EXPN) has a number of ways of growing in the future. I think growing demand for loans should help boost volumes, but the most important growth avenue involves increasing prices.
The company has data collected from hundreds of sources. And this gives the FTSE 100 company a unique ability to produce detailed reports on the creditworthiness of potential borrowers.
The biggest threat to Experian’s ability to gradually increase prices over time is the US shifting to a system where fewer reports are needed for originating mortgages. And this is a real possibility.
I think, however, that the low price of a credit report compared to the risk it helps reduce means there’s still scope for further increases. As a result, I expect the firm to keep growing for a long time to come.
Rentokil
In the case of Rentokil (LSE:RTO), I think there are two main strategies for growth. The first is increasing volumes and the second is lowering costs.
Climate change is actually a long-term boost for the company. Wetter winters and warmer summers create better breeding environments for pests, which should result in more bookings.
Rentokil is also in the business of attempting to become more efficient. The firm is looking to integrate a big acquisition from 2022 and it expects to be able to lower its costs in the future.
As a services business, one of Rentokil’s biggest costs is its people, making wage inflation cutting into profits a substantial risk.
Aiming for a million
Starting from scratch, a return of 6.5% per year is enough to turn a £1,000 monthly investment into something worth more than £1,000,000 after 30 years. And I think that’s highly achievable.
The key is finding firms that can increase their earnings not just for 10 or 15 years, but for the very long term. There are never any guarantees, but I think Experian and Rentokil have a better chance than most.
