When your goal is establishing a reliable, long-term, dividend-based passive-income stream, you have to analyze the sustainability of the dividends from a deeper perspective. The payout ratio is supported by the company’s finances, which, in turn, rely on the business model and the stability and consistency of its revenues.
This is where utility stocks stand out among other dividend stocks. They generate most of their revenues from utility bills that consumers pay every month. Since it’s necessary spending, neither residential nor commercial consumers stop paying their utility bills, regardless of their financial condition.
This makes the revenues of utility companies and, in turn, their finances more stable. One major consequence is financially sustainable dividends.
There are exceptions, but that’s usually the reason why utility stocks are an ideal pick for a tax-free dividend stream from your TFSA.
Source: Getty Images
Algonquin power and utilities
Algonquin Power and Utilities (TSX:AQN) has a different business model than typical utility stocks. The company does both — i.e., generate electricity and distributes it as a utility company. The two business segments worked well in the past, and Algonquin’s focus on renewables kept the stock going up at a decent pace, but the company’s poor debt management has finally started to weigh it down.
The company announced a 40% dividend cut starting with the first quarter of 2023 and is planning to sell $1 billion worth of assets to settle its most demanding debt segment. It will still leave the company with considerable hard assets, but the news disastrously impacted the stock price.
The stock fell off a cliff in Aug. 2022 and is still trading at a 43% discount from its last peak. This has resulted in its “expulsion” from the pool of large-cap stocks on the TSX. The yield will suffer a significant blow as well.
However, there is still reason to consider Algonquin as a long-term holding: it’s potential for recovery. The underlying business (utilities) is still strong, and if the company starts recovering (financially) with proper debt management, it may restart growing its payouts.
Fortis
Fortis (TSX:FTS) is an exemplary dividend stock. It has been growing its payouts for almost five decades and has experienced relatively consistent and modest growth in the last two decades. If you buy Fortis now, lock in the 4.1%, and hold it in your TFSA, you may enjoy a steady passive-income stream for decades.
Since it’s an Aristocrat, there is a high chance that the dividend income you get from Fortis will keep on growing at a decent pace. Even if it’s not enough to fully stave off inflation, the payout growth might still lessen its impact. The stock’s growth, while modest, can keep your capital growing ahead of inflation.
Foolish takeaway
Utility blue-chip stocks like Fortis can be ideal for setting up a passive, hands-free income stream that augments your primary income. If you start this income from your TFSA, you also don’t have to worry about it inflating your tax bill.
