My favorite kind of money does three things.
First, it grows. And it keeps growing every single year – by double digits.
Second, and unlike most corporate profits, it only gets taxed once.
And third, it's "lean." The businesses paying my favorite kind of money are very sensitive to cost, while retaining virtually no earnings. After all, they have to pass through nearly all their income to investors.
Few investments give you all three of these benefits, of course. That's what makes the shares below so attractive.
First, let's look at each of my "favorite money factors" more closely…
Factor No. 1
Financial planners like to put you in one of two camps:
The "growth camp," which they say is right for younger investors, and the "income camp," which they say is proper for retirees and those close to retirement.
As we've said before, don't believe it. In reality, growth and income are inseparable.
There's only one reliable way to make 10% or more a year… especially now, in a rising interest rate environment.
We have to seek total return. For me, this means targeting companies that:
- generate decent current income, around 5% to 10% a year, and
- support that income with strong underlying business fundamentals… resulting in another 5% to 10% of capital appreciation.
So, seeking yield alone is dangerous. It can suck you into bad investments. After all, a high yield is high for a reason.
Factor No. 2
A Brilliant Tax Structure
My favorite kind of money comes directly to me, and it doesn't make any stops along the way, either. That's why I like master limited partnerships (MLPs), real estate investment trusts (REITs), business development corporations (BDCs), and private equity firms.
You see, all of these companies are organized as pass-through entities. They're set up differently than traditional public corporations. While traditional corporate structures are designed to retain earnings, pass-through entities such as these are designed to funnel at least 90% of their earnings directly to shareholders.
And you'll get to keep far more of your pass-through profits, too.
For shareholders, pass-through securities offer the limited liability protection of traditional corporations, but without the infamous double tax bite you'd normally take from Uncle Sam.
Because pass-through securities' cash flow is paid out to shareholders – without corporate tax – and is only taxed once at the partner level.
The reason for this is due to the legal structure of pass-through securities, which, as I've mentioned, are set up to distribute at least 90% of their earnings directly to shareholders or unitholders.
This single taxation, as opposed to the double taxation on traditional corporations, means dividend payouts from pass-through entities are bigger – much bigger. As we'll see, this makes many of their annual dividend yields much more attractive.
How these entities treattheir own money is pretty impressive, too.
Factor No. 3
Highly Efficient Management
Because these companies are obligated to distribute some 90% of their earnings to unitholders, there is little in the way of retained earnings left… for management to spend on perks such as private jets and $500,000 holiday parties. This forces MLPs to be lean and efficient, compared to traditional corporations, fat with cash.
Because of lower taxes, cash-producing assets such as oil wells become more profitable under MLP ownership than corporate ownership. Many MLPs take advantage of their favorable tax structure by buying oil wells from energy companies barely making money on these wells after-tax.
You'll love the yield, too.
Of course, the most attractive aspect of pass-through securities is their outstanding yields. While most energy stocks offer yields of about 3%, most of the biggest energy MLPs offer yields in the 8% to 10% range. This kind of yield is something that's attractive to most investors, especially those who are focused on generating income from their existing assets.
I remember the 1980s, when Congress first approved the use of MLP structure in energy exploration and production firms. I knew then, as now, that this unique approach had a bright, and profitable, future ahead of it. It wasn't long after approval that other companies in other industries made the move to become pass-through entities. The tax advantages alone made sure that happened. And three decades later, we have much more to choose from: MLPs, REITs, BDCs, and private equities.
They're different securities, of course, but they're all my favorite kind of money.
What I'm Looking at Right Now
These shares all represent MLPs, REITS, BDCs, and private equity. There are plenty of great investments in this group, but these are my very favorites: