I love income. But all too often, income investors are missing out.

Let me tell you why…

When we’re focused on generating income, we do it because we like the money in our pockets.

We see too many companies these days frittering away their earnings on overpriced acquisitions or frivolous “stock-based compensation.”

So, we like to make sure we’re paid our share of the business’s income… via a dividend check in our hands.

But that can limit us. Even as income investors, we’re still investors.

Most of us retirement-age investors haven’t fully switched over to spending our savings. We like income. We use it to fund our lifestyle. But we’re still able to put much of that income back into other investments.

That leaves us with a problem… By focusing on the best income-producing investments, a lot of folks miss out on a class of magical, high-return stocks called “compounders.”

You can benefit from these stocks at any stage in your investing career. And as I’ll explain, you don’t have to sacrifice income to do it – because some of these companies allow you to have it both ways…

Compounders generate high returns – something like 15% per year – for decades on end. (And 15%, over a decade, quadruples your money.)

True compounders, however, are rare. To be one, a company needs to accomplish at least three difficult things…

  1. It needs to have a high-quality, defendable business that generates lots of free cash flow.
  2. It needs a management team that understands and carefully assesses how to deploy capital.
  3. And it needs opportunities to reinvest that capital in its business.

You likely know about the power of compounding over time. You know that small investments lead to big differences in your wealth over the long run.

And compounders do the same… But they tend to earn higher returns by compounding their wealth inside the company.

That doesn’t particularly align with paying dividends to shareholders. So you might be tempted to overlook them when you’re focused on income investments.

But with certain compounders, you can enjoy both benefits…

These companies split their earnings between reinvesting in the business and paying investors a decent dividend.

One sector that’s full of these compounders is the distribution business…

That might sound dull at first. But few things can reward shareholders better than distribution.

Instead of designing or manufacturing products, a distribution company simply collects them all in one place… and then passes them along to the buyers who need them – usually another business, rather than individuals.

Distributors can be great compounders. They don’t take a lot of capital. The only investments they make are in warehouses and inventory. And if they can truly capture their market, they can earn great profit margins.

That leads to great returns for investors.

Take W.W. Grainger (GWW), for instance. The company distributes parts and supplies to industrial firms. In the chart below, you can see its stellar long-term performance…

Other distributors like Sysco (SYY), which sells food to restaurants, and Watsco (WSO), which distributes HVAC equipment, have also become classic compounders…

Here’s one thing about compounders… They tend to trade for high valuations.

However, that’s because if you do the math, a business that has an internal return of 20% or 30% is very valuable. With rates of return that high, valuations almost don’t matter.

Compounders offer us the opportunity to start with a small yield… and see it grow into a big one.

These companies will return more capital to shareholders via dividends and buybacks. Meanwhile, they will continue to invest in their business.

So, if you find a real, true compounder, you can justify paying up for it. And classic distributor businesses are a great place to consider putting money to work.

Here’s to our health, wealth, and a great retirement,

Dr. David Eifrig

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Source: Daily Wealth