Whether you use the TFSA for retirement planning or as a vehicle to save for a big purchase, the best way to get the most out of the product might be to hold dividend-growth stocks.
Why?
The TFSA allows investors to keep all of their dividend income and reinvest it into new shares. Over time, the power of compounding can turn a relatively small initial investment into a very large sum of money.
Two attractive companies that demonstrate how well this works are Royal Bank of Canada (TSX:RY)(NYSE:RY) and Canadian National Railway Company (TSX:CNR)(NYSE:CNI).
Royal Bank
Royal Bank earned just under $10 billion in profits last year. That’s an insane amount of money, and it shows just how efficient the company is at finding ways to make a buck during difficult economic times.
The big reason for Royal Bank’s success is the fact that it has a diversified revenue stream. The company’s retail business is very strong, and it relies heavily on capital markets and wealth management activities to drive income.
The bank is also making a big push into the U.S. private and commercial banking sector with its recent acquisition of City National. The deal will add a nice U.S.-based revenue stream, and investors should see the operation grow in the coming years.
Royal Bank is not immune to the woes in the energy sector, but the bank has less than 2% of its total loan book exposed to oil and gas companies, so investors shouldn’t be overly concerned about loss provisions.
On the housing front, the company’s Canadian residential mortgage holdings are in good shape. Only 54% of the mortgages are uninsured, and the loan-to-value ratio on that portion is 55%. This means the housing market would really have to fall out of bed before Royal Bank takes a material hit.
Management just increased the quarterly dividend by 3% to $0.81 per share, which provides a yield of 4.3%.
A $10,000 investment in Royal Bank 20 years ago would now be worth $211,000 with the dividends reinvested.
CN
The railway business is a good one to be in because the barriers to entry are so high. Think about it. What are the odds that a competitor would ever build a competing line along CN’s existing routes? Pretty much nil!
The story gets even better.
CN is the only North American railway that connects to three coasts. This gives it a great competitive advantage when securing business from intermodal customers who need to ship products across Canada or down through the heart of the United States.
The company has great infrastructure, but it is also extremely cost effective. In fact, CN is regularly cited as the most efficient company in the industry, and that is a big reason why it continues to deliver amazing results amid a downturn in the commodity cycle.
In Q4 2015, CN reported net income of $941 million, up 11% over the same period in 2014 despite a slight drop in year-over-year revenue.
The company recently increased the dividend by 20%, and investors have enjoyed annual hikes averaging 17% over the past two decades.
And the returns?
An investor who purchased $10,000 of CN stock just 15 years ago would now be sitting on $122,000 with the dividends reinvested.
