By Compounding Academy
In this issue, we kick off a mini-series dedicated to exploring What Makes a Quality Business. We begin with a deep dive into the foundation of successful compounding: Predictable Revenue Growth
Compounding depends on uninterrupted growth
A business with highly predictable, needs-based, recurring revenues is like a river that flows steadily year after year. In contrast, a business tied to volatile demand — driven by economic cycles or commodity prices — is like a river that floods or dries up unpredictably. Investors exposed to unpredictable businesses experience painful drawdowns, interrupted growth, and subpar compounding.
Its membership model locks in recurring revenues. Membership renewal rates exceed 90%, and core product demand remains steady — groceries, household staples, and essential goods. Impressively, Costco has sustained an annual revenue growth rate of 9.5% over the past 30 years, a testament to its resilience amid various economic upheavals, as illustrated in the following chart.
Uninterrupted compounding at high returns on invested capital has translated into impressive share price compounding……..
The Danger of Unpredictability: US Steel
Now lets contrast US Steel with Costco. Companies that lack revenue visibility or are overly sensitive to economic fluctuations pose a risk to investors, especially during recessions when revenues can implode. Steel is a cyclical commodity heavily tied to global economic health, industrial demand, and pricing swings. US Steel’s revenues have been volatile for decades.
The inherent volatility in US Steel’s economically sensitive revenues has translated into an even more choppy share price performance. Its stock price has followed a boom-and-bust pattern, creating little wealth for long-term shareholders. This is the trap: even if management executes well, a business fundamentally tied to volatile forces struggles to compound value consistently.
To mitigate such risks and maintain steady growth, we prioritize investing in companies with predictable revenue streams that can grow irrespective of economic cycles. This approach helps in maintaining a consistent and resilient compounding effect over time.
To identify companies capable of compounding reliably, we focus on structural traits that drive consistent, repeatable revenues. Here are some of the patterns we pay close attention to in high-quality businesses:
Needs-Based Products & Services
Essential goods or services that consumers or businesses must purchase regardless of economic conditions. Here are some examples to consider:
Novo Nordisk’s diabetes treatments and Demant’s hearing aid solutions, are both crucial to their customers irrespective of economic conditions.
Tractor Supply’s animal products and AutoZone’s vehicle parts ensure constant demand for these essential consumables, critical even when the economy falters.
Essential office supplies from WW Grainger and Salesforce’s CRM platform remain in demand, proving resilient even when corporate budgets tighten.
Recurring revenue models create predictability by locking in repeat customer payments. Microsoft 365 and Adobe Creative Cloud are perfect examples — mission-critical platforms that businesses rely on daily. Once embedded, these tools are rarely switched, making revenue streams highly resilient.
Regulatory Barriers & Government Reliance
Some companies enjoy stability because regulation makes their markets harder to enter. Heico benefits from aerospace compliance requirements that limit competition, while Lockheed Martin earns consistent revenue through long-term government contracts. In both cases, the environment protects incumbents and underpins predictable cash flows.
By identifying companies that exhibit these traits, we aim to identify opportunities that promise not just growth, but stable, sustainable growth. This underpins our strategy: to invest in businesses capable of delivering the kind of reliable compounding that builds wealth over time.
Pick 3 companies you own or follow. Ask:
These questions will help you filter out fragile growth — and zero in on businesses built for long-term compounding.
Some of the companies mentioned here — like AutoZone, and Adobe— are featured in our library of one-pagers, video teach-in series and Business Quality Assessments, all available on our website. You can explore these breakdowns — and many more — in our free one-pager library and Business Quality Assessments, available now.
We also offer a free short course covering our complete Mindset SQUARED™ framework — the exact process we use to screen, assess, and select quality compounders.
If you want to dig deeper or start applying this philosophy to your own portfolio, these resources are a great place to begin.
In our next Newsletter we’ll explore Competitive Advantage – one of the most important characteristics of any great business. See you next time!