Reasonable growth: 8 criteria to assess a fast-growing company

Who it is for

This strategy is for investors looking for fast-growing companies, often in technology or software, without accepting any valuation at all. It follows the “growth” style of the factor families, with two safeguards: the price paid for that growth, and the company’s ability to fund it on its own.

The 8 criteria, one by one

Revenue growth over 3 years

This is the engine of the strategy. The period is shorter than for quality (3 years instead of 5), because a young company changes fast. At 15% a year or more, revenue roughly doubles in five years. See the revenue growth entry.

Growth in earnings or FCF per share over 3 years

Revenue growth that does not show up in earnings per share does not benefit shareholders. The criterion accepts FCF per share instead of earnings, which is more telling when profit is still small. Measuring per share takes dilution into account.

Gross margin

The threshold is higher than for quality (50% instead of 40%). A growing company spends heavily on sales and research. A high gross margin gives it the means to do so and suggests strong profitability once growth slows.

PEG

The PEG ratio divides the P/E by the expected annual earnings growth. Popularized by Peter Lynch in “One Up on Wall Street”, it asks a simple question: is the P/E justified by growth? Up to 1, the P/E does not exceed the growth rate. Above 2, the valuation already prices in a lot. A PEG ratio calculator is available on the site.

Revenue growth + FCF margin

This is the “rule of 40”, a common benchmark for software companies: growth plus FCF margin should reach 40%. A company growing at 30% can afford a 10% margin, while one growing at 10% needs a 30% margin. The app adds up the two values you enter. See the rule of 40 entry.

Annual dilution

Growing companies often pay their teams in shares, or raise money by issuing new stock. Each new share shrinks the stake of existing shareholders. Green tolerates 2% dilution a year, red starts above 5%.

Net cash or positive FCF

A yes or no criterion: does the company have more cash than debt, or positive free cash flow? If neither condition is met, it depends on new financing to keep growing, often at the cost of dilution.

Target market and edge

A text criterion, never scored. You describe the size of the market, the share the company can win and what sets it apart from its competitors. See the competitive advantage entry.

Why these thresholds

The 15% growth threshold separates fast-growing companies from those that simply follow their market. A PEG of 1 and the rule of 40 are public benchmarks, widely used by analysts. They are only starting points: a PEG of 1.5 on very steady growth may seem acceptable to you.

The dilution thresholds reflect the common practice of stock-based pay in technology, which is higher than elsewhere.

Limits

Past growth does not extend itself. High growth rates almost always slow as a company gets bigger, and the PEG rests on future growth that nobody knows. An estimation error of a few points changes the result sharply.

The strategy looks neither at future competition, nor at the quality of management, nor at dependence on a few customers. For a company that is still loss-making, the PEG and earnings per share growth make no sense: tick “Not applicable” and rely on FCF and the rule of 40.

Each criterion’s verdict is an aid to thinking. The decision remains yours.