When I started investing, I was solely focused on owning dividend stocks. I felt that earning a tangible dividend on a regular basis was a comforting way to earn a return. There is nothing like earning tangible cash income, especially when the market is volatile.
Dividends are great, but compounders could be better
Frankly, there is nothing wrong with this approach. Many Canadians invest in stocks to earn passive income. I think every portfolio should have some exposure to dividend stocks.
However, I think owning stocks in high-quality businesses that can compound most or all their earnings/cash flows is an even more effective way to invest. In fact, I wish that I had started letting my investments compound my wealth for me earlier on in the journey.
A top Canadian software stock
For example, if I had $20,000 of capital to invest 10 years ago, I should have bought a stock like Constellation Software (TSX:CSU). Constellation stock is up 1,822% over the past decade (not including spin-outs). Over the past 15 years, it is up almost 100 times!
Constellation only pays a pitiful 0.25% dividend yield. In contrast, it utilizes its profits and cash flows to invest into acquiring niche software businesses around the globe. It buys these at bargain prices, strengthens their business models, and then reaps their high cash flows to buy more businesses.
Constellation business is the picture of compounding. This stock is almost never cheap, yet it consistently delivers incredibly strong returns. If I could go back, this would be one of the first stocks I’d buy.
A top retail stock
Another high quality stock I should have bought a decade ago is Alimentation Couche-Tard (TSX:ATD). Even though it operates a mundane business (gas stations and convenience stores), it has delivered spectacular returns.
Its stock has delivered over 600% total returns since 2013. That is a 21% compounded annual growth rate. A $5,000 investment would be worth $35,343 today.
Part of Couche-Tard’s secret sauce is its ability to acquire portfolios of gas stations at very attractive prices. It then applies operating expertise and brand power to drastically improve operations and profitability.
Couche-Tard is very well managed. Insiders have a large stake in the business. Managers are aligned with shareholders, and that tends to spell out very well for long-term investors.
A global consulting firm
WSP Global (TSX:WSP) is another stock I wish I’d bought sooner. Like the stocks above, its business is not overly flashy. It provides consulting, engineering, and design services around the globe. What makes the difference is its scale and broad expertise. Today, it is one of the world’s largest consulting companies.
In fact, its stock is up 621% over the past decade. A $5,000 initial investment would worth $36,500. There are reasons to be optimistic about the future. Engineering and consulting firms are insanely busy these days.
There is a lot of demand for WSP’s services. Recent large acquisitions have helped propel it into key spaces like environmental services. Like Constellation, this stock is not cheap, but any major pullback would make it a great long-term buy.
The Foolish takeaway
While there is nothing wrong with stocks that pay dividends, companies that can effectively compound most or all their earnings can deliver far superior returns (especially if they get years and decades to do so).
Stocks like Constellation, Couche-Tard, and WSP have demonstrated an operational and financial secret-sauce that earned them great past returns and the potential for strong returns in the future.
