In the ever-turbulent landscape of stock markets, investors are constantly seeking strategies that not only weather short-term volatility but also compound wealth over the long haul. This week’s market action—marked by an early selloff followed by a resilient rebound—underscores a crucial insight: amid noise and uncertainty, the power of steady compounders shines brighter than ever.
Why Compounders Are Your Best Bet Right Now
As we saw on Thursday, major indexes like the S&P 500 flirted with losses early in the day, dragged down initially by concerns despite Nvidia’s strong earnings. Yet, by day’s end, the S&P 500 closed above 6,500 for the first time—a testament to the underlying resilience in quality stocks. This pattern of initial dips followed by recovery has been a theme throughout the week, reflecting ongoing investor anxiety about tech valuations, tariff impacts, inflation, and political interference with the Federal Reserve.
Adam Parker, founder and CEO of Trivariate Research and a former Morgan Stanley chief U.S. equity strategist, offers a compelling prescription: focus on “compounders” — companies that consistently grow their gross margins, revenues, and net margins while maintaining strong price momentum. Parker’s research reveals that stocks in the top 10% for consistent gross margin expansion outperform the market over subsequent periods.
The Metrics That Matter
Trivariate’s approach hinges on four key growth metrics:
- Gross Margin Growth: A company’s ability to increase the difference between revenue and cost of goods sold, signaling operational efficiency and pricing power.
- Revenue Growth: Sustained top-line expansion is vital for long-term value creation.
- Net Margin Growth: Reflects profitability after all expenses, a sign of effective cost management.
- Price Momentum: Stocks that have shown upward price trends tend to continue benefiting from investor confidence.
Among these, gross margin growth stands out as the strongest predictor of future stock performance.
Stocks Leading the Charge
Parker identified over three dozen firms with 12 consecutive quarters of gross margin expansion, with 22 expected to continue this trend. Noteworthy names include:
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Amazon (AMZN): Despite trailing the “Magnificent 7” tech giants like Alphabet and Nvidia in year-to-date gains, Amazon’s 48.85% gross margin and consistent margin growth make it a stalwart compounder. Its better-than-expected Q2 results and conservative operating income guidance suggest prudent management amid market uncertainties.
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Eaton (ETN): A leader in electrical equipment and data center infrastructure, Eaton’s shares surged 21% over six months, nearly doubling the S&P 500’s return. Despite a recent pullback on a cautious Q3 outlook, 21 out of 32 analysts rate Eaton as a buy or strong buy, underscoring confidence in its long-term growth.
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Coupang (CPNG): South Korea’s e-commerce titan has soared over 28% year-to-date, with gross margins widening by nearly 5 percentage points over two years. Notable investors like Josh Brown and Sean Russo of Ritholtz Wealth Management highlight Coupang’s robust fundamentals and growth runway.
Other names like Airbnb and AT&T also appear on Trivariate’s radar for reliable margin expansion.
The Bigger Picture: What Investors Should Do Now
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Shift Focus to Quality Over Hype: With macroeconomic uncertainties and geopolitical risks looming, chasing speculative tech rallies can be perilous. Instead, prioritize companies with proven operational leverage and margin expansion. These firms tend to generate free cash flow that can fuel innovation, dividends, and share buybacks—key drivers of long-term returns.
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Incorporate Margin Expansion Metrics Into Screening: Traditional valuation metrics like P/E ratios might not fully capture a company’s growth quality. Investors should add gross margin growth and net margin improvement as filters to identify sustainable compounders.
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Prepare for Interest Rate Sensitivity: As the Federal Reserve faces political pressure yet remains cautious on rate cuts, companies with strong margins and pricing power are better positioned to absorb inflationary pressures and rising borrowing costs.
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Global Diversification Matters: Coupang’s example highlights the value of looking beyond U.S. borders for compounders. Emerging markets and innovative platforms in Asia offer compelling growth stories that can complement domestic holdings.
What’s Next?
Market volatility is unlikely to abate soon, given ongoing inflation concerns, geopolitical tensions, and political interference in monetary policy. However, investors who anchor their portfolios in companies with consistent margin expansion and operational excellence stand to outperform over the next several years.
A recent report from Morningstar echoes this sentiment, emphasizing that “quality growth stocks with strong free cash flow generation and margin resilience are best positioned to navigate uncertain macro environments.” Moreover, a study by J.P. Morgan found that portfolios tilted towards companies with improving gross margins delivered 3-5% higher annual returns over a decade compared to the broader market.
Actionable Takeaway for Advisors and Investors
- Rebalance portfolios to increase exposure to compounders identified by margin growth metrics.
- Use active management or smart beta strategies focused on quality growth to capitalize on this trend.
- Monitor margin trends quarterly as an early warning system for potential earnings surprises or operational issues.
- Educate clients about the importance of patience and focusing on long-term compounders rather than chasing short-term momentum.
In conclusion, while headline risks and market noise dominate the headlines, the quiet power of compounders—those companies relentlessly improving their margins and profitability—offers investors a beacon of stability and growth. For those willing to look beyond the daily volatility, the path to wealth creation lies in these consistent performers. At Extreme Investor Network, we believe that mastering this approach is not just smart—it’s essential for thriving in today’s complex market environment.
Source: Buy stock ‘compounders’ for the long-term, Trivariate Research says