Canadians are using their Tax-Free Savings Account (TFSA) and Registered Retirement Savings Plan (RRSP) to build self-directed retirement portfolios. One popular investing strategy involves buying top TSX dividend stocks and using the distributions to acquire new shares.
Power of compounding
Building a retirement fund using top dividend-growth stocks can be a bit like rolling snowball down a hill. When dividends are reinvested in new shares the next distribution is larger and can potentially buy even more new shares. The impact of the process is small at the beginning, but, over time, it can turn a relatively modest initial investment into a meaningful savings fund, especially when dividends increase steadily and the share price drifts higher.
Top stocks to consider for this strategy tend to be ones with great track records of dividend growth supported by rising revenues and higher profits.
Fortis (TSX:FTS) is a Canadian utility company with $65 billion in assets located across Canada, the United States, and the Caribbean. The company produces power, moves electricity, and distributes natural gas. The businesses typically operate under regulated rate structures. This means cash flow tends to be predictable and reliable.
Fortis stock trades near $58 per share at the time of writing compared to a 12-month high around $65. Buying the stock on dips has historically proven to be a profitable move.
Fortis has raised its dividend in each of the past 49 years. The board plans to increase the payout by at least 4% per year through 2027 supported by the current $22.3 billion five-year capital program. Fortis also grows by making strategic acquisitions.
Investors who buy Fortis stock at the current level as of writing can get a 3.9% dividend yield.
TD (TSX:TD) had to put its dividend hikes on pause during the pandemic due to a ban imposed by the government, but the company picked up right where it left off when banks received the green light to hikes rates again in late 2021. Over the past 25 years, the dividend has increased by a compound annual rate of better than 10%.
TD stock trades near $82.50 at the time of writing compared to $93 in February.
The pullback in recent months occurred as part of a broad selloff in bank stocks caused by bank failures in the United States.
Recession fears and the impact of soaring interest rates are putting bank risks in the headlines. Commercial real estate loans and residential lending are on the minds of investors. TD’s commercial real estate portfolio was $89 billion as of the end of February. Office buildings account for 10% of the portfolio. On the Canadian residential housing side, TD had $359 billion in the portfolio at the end of the fiscal first quarter of 2023. The loan-to-value (LTV) ratio is about 50%.
A crash in commercial and residential housing markets caused by a wave of bankruptcies and defaults would be bad for TD and its peers. However, things would have to get pretty ugly before TD takes a material hit. Economists broadly expect a mild recession to occur late this year or in 2024.
TD just cancelled its planned US$13.4 billion purchase of First Horizon. This means TD is now sitting on a mountain of excess cash that will help it ride out any potential market chaos. It will likely also put a cap on upside in the stock price until TD decides what to do with the extra money.
Near-term volatility should be expected, but investors might want to start nibbling on TD stock while it is out of favour. The dividend currently provides an annualized yield of 4.7%.
The bottom line on top TSX dividend stocks
Fortis and TD are good examples of top TSX stocks with great track records of delivering dividend growth and total returns. If you have some cash to put to work in a self-directed TFSA or RRSP, these stocks deserve to be on your radar.