Canadians are using their self-directed Tax-Free Savings Accounts (TFSAs) to build retirement portfolios to complement government and company pensions.
One popular investing strategy to create retirement wealth involves buying top TSX dividend stocks and using the distributions to acquire new shares.
Source: Getty Images
Power of compounding
Each time a dividend payment is used to buy new shares, the next dividend payout is larger, which, in turn, can buy even more shares depending on the movement of the stock price. The impact on the size of the holding is small at the beginning but can become substantial over the course of 20 or 30 years, especially when dividends grow at a steady pace and share prices drift higher.
Dividend-reinvestment plan (DRIP)
Companies generally like it when investors use dividends to buy new shares as it keeps cash in the business. This can be used to fund capital programs or reduce debt. To give investors an added incentive, many firms offer a discount on the price of the stock purchased using the distributions. The discount is normally in the 2% to 5% range.
Fortis
Fortis (TSX: FTS) is a Canadian utility company with $75 billion in assets spread out across Canada, the United States, and the Caribbean. The businesses include power generation facilities, electricity transmission networks, and natural gas distribution utilities. Revenue is primarily rate-regulated. This means cash flow tends to be predictable and reliable, which helps management plan for growth.
Fortis is currently working on a $26 billion capital program that will increase the rate base from $39 billion in 2024 to $53 billion in 2029. As the new assets are completed and start generating revenue, the boost to earnings should support planned annual dividend increases of 4% to 6% over the next five years. Fortis has other projects under consideration that could get approved. This could extend the dividend-growth guidance or even raise the size of the increases.
Fortis bumped up the dividend payment in each of the past 51 years, so investors should be comfortable with the guidance. At the time of writing, Fortis provides a dividend yield of 3.8%. The company offers a 2% discount on the share price for investors who enrol in the DRIP.
Returns
Steady dividend growth supported by rising revenue and higher profits tends to be positive for the share price over the long haul. For example, a $10,000 investment in Fortis stock 20 years ago would be worth more than $70,000 today with the dividends reinvested.
Market pullbacks occur and can be substantial. Fortis saw its share price slide from $64 to about $50 over six months in 2022 when the Bank of Canada and the U.S. Federal Reserve aggressively raised interest rates. The dip gave investors a chance to buy more shares with their dividend payments. The stock is now back above $64 per share.
The bottom line
Stocks come with risks, and dividends can get cut if a company runs into financial troubles. That being said, most top dividend-growth stocks on the TSX, like Fortis, should be solid picks for a buy-and-hold TFSA portfolio focused on long-term total returns.
