By Teresa Rivas

Sure things don't exist in the stock market, but compounders come close. Companies that invest their profits back into the businesses at a high rate of growth over years outperform the broader market -- the question is how to find them.

Trivariate Research Founder Adam Parker is tackling that question again. Previously he noted consistent gross margin expansion blew most other metrics out of the water when it came to identifying multiyear compounders.

It might be tempting to conclude free cash flow margin is similarly effective, and it does beat out some other metrics, but analysis shows not all margins are created equal.

Parker looked at free cash flow margin -- defined as the cash flow from operations minus capital spending, all divided by revenue -- and found it wasn't a consistent indicator for the top 2,000 equities by market capitalization, excluding financials.

It is true that, on a trailing basis, the top quintile of free cash flow margin stocks has beaten the bottom quintile by a cumulative 250% over the past 26 years. Not too shabby.

However for forecasted free cash flow margin, "the spread has been far less effective, only 100% cumulative return from the spread in over 15 years," Parker writes. "Recently, free cash flow margin has failed since peaking at the end of May. The change in free cash flow margin, either forecasted or backward looking, has not been as effective over the last 25 years."

Part of the difference may be that it takes longer to be a top gross margin grower. To be in the top 10% of companies for this metric requires 12 straight quarters of gross margin expansion, while the top decile of free cash flow margin growers only needed seven consecutive quarters of expansion.

It can also depend on the kind of stock in question, as Parker found free cash flow margin works better as a predictor for megacap companies than smaller ones. Ditto for growth stocks over value, but this comes with a caveat, as the pattern hasn't held up in recent months.

That said, to give credit where due, companies that excel in growing free cash flow margin do outperform other metrics including upward earnings revisions, revenue growth, net income growth and price momentum. They also beat the S&P 500 over the past two decades.

With that in mind, he offers a list of 13 free cash margin growth compounders, which in order of market cap are Uber Technologies, Shopify, Eaton, Roblox, ResMed, GoDaddy, Guidewire Software, F5, Unity Software, Elastic, Wix, Dutch Bros, and Lyft.

In an uncertain world that often seems to favor flashy artificial intelligence names over slow but steady winners, there are worse ways to pick stocks.

Write to Teresa Rivas at teresa.rivas@barrons.com

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September 15, 2025 13:10 ET (17:10 GMT)

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