How should you invest your TFSA money?
Many people hold GICs in their TFSA accounts. This is a wise decision if the cash is needed in the near term, but when the funds are being invested for two or three decades the best option for the TFSA might be dividend-growth stocks.
Why?
The tax-free structure allows you to reinvest the full value of dividends in new stocks. This sets off a powerful compounding process that can turn a small initial investment into a large nest egg over a number of years. Once the time comes to use the funds, all gains are protected from the taxman.
Which stocks should you buy?
Look for companies with long track records of rising dividends. Ideally, these names also hold dominant positions in industries with wide moats.
Let’s take a look at Royal Bank of Canada (TSX:RY)(NYSE:RY) and Canadian National Railway Company (TSX:CNR)(NYSE:CNI) to see why they might be attractive picks.
Royal Bank
Royal Bank is a profit machine. The company earned just under $10 billion last year, and the results for the first half of fiscal 2016 suggest the bank is on track to meet or exceed that milestone this year.
With the Canadian economy facing some challenges, Royal Bank has decided to invest in the United States. The recent US$5 billion acquisition of California-based City National gives the company a solid growth platform to expand its presence in the U.S. private and commercial banking market. Investors should see the U.S. operations become more significant in the coming years.
Royal Bank is changing with the digital times. Management is forging key FinTech partnerships and investing in new mobile banking initiatives to ensure the company meets the demands of its younger customers. The industry is certainly changing, but Royal Bank still holds a very comfortable spot in the cozy Canadian banking industry, and that situation is not likely to change.
The company has doubled its dividend in the past decade.
A single $10,000 investment in Royal Bank 15 years ago would be worth $56,000 today with the dividends reinvested.
CN
CN is working its way through a slow patch in the economic cycle, but the company is still generating solid earnings and free cash flow.
Net income for Q2 2016 came in at $858 million, or $1.10 per share, pretty much in line with the same period last year. At first glance, the year-over-year numbers aren’t overly exciting. In fact, revenue is down in all segments other than forestry.
But CN is very efficient and continues to churn out carloads of excess cash. In the first six months of 2016, CN generated $1.17 billion in free cash flow, up from $1.05 billion in the same period last year.
Free cash flow is important because it is used to pay dividends and buy back shares. CN raised its dividend by 20% earlier this year and has delivered an annual dividend increase of about 17% over the past two decades.
CN is the only railway in Canada and the U.S. that can offer service to three coasts. The odds of new lines being built along the same routes are pretty much nil, so CN has a great competitive advantage that should endure for decades.
What about returns?
A $10,000 investment in CN just 15 years ago would be worth $99,000 today with the dividends reinvested.
Is one a better pick?
Both Royal Bank and CN are great long-term holdings. Earlier this year I might have favoured Royal Bank, but the big run in bank shares has taken away the advantage. At this point, it’s probably a coin toss between the two stocks.
