Buying high-yielding dividend stocks is a popular investment strategy in the UK. It’s basic to see why – with this strategy, an investor can reinvest their dividends and take advantage of the power of capitalization (achieving returns on previous rates of return).

But dividend stocks aren’t the only way to boost your returns with a stocks and shares ISA or SIPP. There is another strategy that can often be even more lucrative.

Compounders can make a lot of money for investors

There are companies on the stock exchange that are not only very profitable, but also capable of constantly reinvesting their profits in future development. These companies (often called “compounders”) often prove to be great long-term investments because they are able to grow their profits internally.

In these types of companies, annual returns of 15-20% over the long term are not unusual. The disadvantage is that they pay very little (or no dividends at all) because it makes more sense to reinvest profits for future growth rather than paying out profits to shareholders.

What to look for

When it comes to finding such companies, there are a few things you should pay attention to.

One of them is a high (over 15%) return on capital employed (ROCE). It is a profitability ratio that measures how effectively a company turns the capital it has into profits.

“If a company earns six percent on equity for forty years, and you hold it for those forty years, you’re not going to make anything other than a six percent return – even if you originally bought it at a huge discount. Conversely, if a company earns eighteen percent on equity over twenty or thirty years, even if you pay an exorbitant price, you’re going to get one hell of a result.”
Warren Buffett’s overdue business partner, Charlie Munger

Another is the source of growth. Ideally, the company will be in a growing industry where it can leverage reinvested profits.

Additionally, you should look for a robust competitive advantage (which stops competitors from stealing market share), a robust balance sheet and a good management team.

British trickster

A good example of a mixture manufacturer on the British market is InterContinental hotel group (LSE: IHG). It is a leading hotel operator, owner of a number of well-known brands, including: Intercontinental, Holiday InnAND Kimpton.

Last year, ROCE was approximately 37%. So it is a very profitable business.

It also has a source of growth – the travel industry is expanding as wealth grows around the world and wealthy baby boomers retire.

As far as stock returns go, they are amazing. Over the last 10 years, the share price has risen from around 2,600p to 10,075p, which translates into an annual return of around 15% per year.

In addition, investors received miniature dividends of around 1-2% per year. Overall, the long-term returns are great.

I’m not saying this stock is something you should consider right now – it’s been on a good run lately and looks a little exorbitant at the moment. There are also some risks from a slowdown in consumer spending.

But there are plenty of other stocks like this on the market London Stock Exchange. And it would be worth taking a look at them today.