How does power of compounding work for an equity mutual fund when it fully depends on the market?

Equity mutual funds invest in the equities of companies. The fund aims to return a good return year on year based on the following TWO factors:

1. Invest only in companies that perform well in the market, and have a potential to grow well. As these companies do well, NAV of the fund goes up.
2. These companies in turn have the ability to price their offerings and are able to increase the price year on year. This beats inflation and the share price goes up resulting in a higher NAV for the fund.

Over a long term the above two factors help a good equity mutual fund to increase its NAV and hence give a consistent growth, resulting in compounding.

Of course, investing only in direct plans helps the fund share more of its growth with the investor. Else about 1.5% goes to the distributor.