A lot of investors still view Warren Buffett as a value investor rather than a growth investor. The truth is that he is both. This quote from his 1996 letter to Berkshire Hathway shareholders sums up his approach quite nicely:

“Your goal as an investor should simply be to purchase, at a rational price, a part interest in an easily-understandable business whose earnings are virtually certain to be materially higher five, ten and twenty years from now.”

I’ve always found it hard to be “virtually certain” about earnings growth.

I think it’s partly because seeing a future of constantly growing profits requires a healthy slice of optimism. And for whatever reason, maybe a childhood spent in Scotland, I am a bit of a pessimist.

I find it easy to think that a great company’s best days are already behind them. Especially if they are already very big. Coke (NYS:KO) has grown its net profits by two-thirds in the past five years. If you’d have asked me in 2018 whether this was a ‘certainty’, I’d have said no. Don’t people drink enough Coke and Sprite already?

The reality is that great companies usually find ways to keep earning more for their shareholders.

My distrust of this probably explains why most of my early investments were firmly on the “value” side of the imaginary line between growth and value. I could never really get comfortable with predicting growth. So I just tried to buy the cheapest shares.

The British fund manager Terry Smith highlighted a key problem with this approach. Once a low-quality company reaches your estimate of fair value, you need to go and find another one. This is very time-consuming. Wouldn’t it be better to make fewer but higher quality investments in the kind of company Buffett describes above?

Doing this would require me to find companies likely to keep growing their earnings for a long time. I put my optimistic cap on and came up with seven reasons this might be the case.

Industry tailwinds

The first source of long-term growth is simple – the market for a company’s core products or services still has room to grow.

This might be because even the best solutions in the company’s industry have low market penetration. Our analysts point to sleep apnea treatment firm ResMed (ASX:RMD) as an example here, as most people with this condition still go untreated. Fineos, which provides software to insurance companies, is another example. According to our analysts, more than half of Fineos’ target market still use in-house systems with far less functionality.

Even if a company’s home markets are saturated, there could be plenty of growth left in other countries and regions. An example I stumbled upon the other day is pest management company Rentokil Initial (LON:RTO). Getting rid of critters might be old news in the US, but it’s an exciting growth market in Asia.

You need to keep in mind here that attractive, high growth industries are likely to attract a lot of competition. For this reason, you want your company to have some kind of competitive advantage that allows them to keep or grow their share of that market as it grows.

Speaking of which...

Market and category share gains

Companies can also grow their sales by taking home a larger percentage of the money spent in their market or broader category.

In Diageo’s 2023 annual report, the management team expressed confidence for three main reasons: “A growing middle class, increased sprits penetration and premiumization”. At least two of those things could bring about better market and category share. According to Diageo (LON:DGE), more people are choosing spirits over other forms of alcohol, which could lead to category share growth. They also think more people are opting for pricier brands like those sold by Diageo, which could bring higher market share.

When it comes to seeing if a company can take market share organically, you need to think about their competitive advantages or disadvantages relative to the competition. This is where an understanding of a company’s moat – and those of its competition – can be very helpful.

Companies can also gain market share by buying other companies. Many industries are still a lot more fragmented than you might realise, which leaves room for consolidation and big market share gains for those doing the consolidating. Of course, the deals need to be done at a price that makes sense for shareholders. Growth at any cost isn’t what you looking for.

Pricing power

Some companies don’t need higher demand to increase profits. They just raise prices instead.

A cherry-picked example here is Altria (NYS:MO), which owns several cigarette brands including the US rights to Marlboro. In 2023, Altria shipped around 30% less cigarettes than it did in 2014. But their revenue was 15% higher. Declining industries are less likely to attract competition and can still deliver sales and profit growth to the remaining companies. In the case of Altria, there are regulatory barriers to entry and its addicted, brand-loyal customers are less likely to resist price increases.

Pricing power without a secular decline in revenues would be even better. Companies that sell crucial products and services at a fraction of their customer’s overall costs can be good candidates. PEXA (ASX:PXA), which facilitates essentially all digital property settlement in Australia, charges under $100 on average for their services. They are a crucial part of housing transactions often worth millions of dollars. Would an extra $10 make users run for the hills?

Switching costs can also contribute to pricing power. If a customer incurs big costs (in money or time) or big risks from changing supplier, that supplier can likely push through bigger price increases without losing the customer.

A focus on markets, not products

The best companies evolve with their markets and keep finding new ways to serve them. This can take the form of new generations of previous products or forming new markets in parallel products. Microsoft (NAS:MSFT) and Coke have both done good jobs here, thanks partly to the huge amount of cash they had to invest in other business lines.

For Microsoft, the age of exponentially growing demand for computers and Windows software ended some time ago. But the needs of companies and workers to collaborate, communicate, document and organise things remains. Finding new ways to serve these needs – be it through cloud computing solutions, AI tools or apps like Teams and PowerBI – means that Microsoft has kept growing the value it delivers and extracts from customers. They have also formed strong positions in other markets like gaming – both organically (with the Xbox) and by acquiring the gaming studios Bethesda and Activision.

Coca-Cola already has strong relationships and distribution networks in the drinks industry and can simply offer more products to their buyers. At first, they stayed in carbonated drinks by adding brands like Sprite and Fanta to their stable. But they’ve increasingly moved into the non-carbonated space with the acquisition of several water, tea and other drink brands. They have also created their own products in new verticals, like the launch of their sports drink Powerade in 1988.

Protection from disruption

If you are betting on a company earning higher profits for decades, you’d probably like to see some kind of protection from new technologies and business models.

One approach here is to go for “low tech” or highly capital-intensive industries where disruption doesn’t seem physically or financially viable. Railroads are an example here. A single rail car holds at least triple the amount of freight as a truck can. This means that one freight train does the work of hundreds of trucks. Even if self-driving lorries remove labour costs from the equation, it still wouldn’t add up.

In the faster moving tech industry, the fact that essentially every business uses Microsoft’s Office ecosystem buys them time to match innovations from other companies. After it launched in 2013, Slack quickly emerged as a new way for employees to communicate without using email services like Microsoft Outlook. It took them four years, but Microsoft eventually realised it didn’t need to acquire Slack to eliminate the threat. They just launched Microsoft Teams instead.

Growth isn't everything

If you find a company meeting some or many of these criteria, there’s a good chance you’ve found a company with the potential to grow its profits for a long time. If you'd like some inspiration, my colleague James Gruber wrote two articles on stocks he'd happily own forever at the right price:

20 US stocks to buy and hold forever

16 ASX stocks to buy and hold forever

And here are some of the companies I mentioned in this article, along with Morningstar's estimate of Fair Value as of 1 October 2024:

Coca Cola (NYS:KO)
Morningstar Moat Rating: Wide
Fair Value Estimate: 64 USD

Diageo (LON:DGE)
Morningstar Moat Rating: Wide
Fair Value Estimate: 3100 GBX

Rentokil Initial (LON:RTO)
Morningstar Moat Rating: Wide
Fair Value Estimate: 620 GBX

Microsoft (NAS:MSFT)
Morningstar Moat Rating: Wide
Fair Value Estimate: 490 USD

ResMed (ASX:RMD)
Morningstar Moat Rating: Narrow
Fair Value Estimate: 40.50 AUD

Fineos (ASX:FCL)
Morningstar Moat Rating: Wide
Fair Value Estimate: 3.10 AUD

PEXA (ASX:PXA)
Morningstar Moat Rating: Wide
Fair Value Estimate: 17.25 AUD

Remember, though, that finding companies with a good growth runway is only one third of Buffett’s formula for success. You also need to buy the shares at a sensible price and hold on. When it comes to figuring out a reasonable price, I would recommend my colleague Mark LaMonica’s checklist for valuing a share.