The TFSA (Tax-Free Savings Account) is the best place to hold stocks that you expect will perform the best over time. When you invest tax-free, you want the biggest possible gains you can find. You don’t want to have to pay any tax on a stock that has multiplied by 5, 10, or 20 times.
A perfect place to look for big gains is in small- and medium-cap stocks. These stocks tend to already have established businesses, but they still have years or even decades to grow.
If you pick these stocks wisely, a $7,000 TFSA contribution could become $150,000 or more.
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A TFSA stock that turned $7,000 into $161,000
Hammond Power Solutions (TSX: HPS.A) is a perfect example. This $2.5 billion company operates a pretty boring business. It manufactures various transformers and electrical grid components.
Five years ago, it was a well-managed, founder-led business that was growing revenues by a high single-digit rate and earnings by a low teens rate. It traded for a mid-single-digit earnings multiple.
Shortly after the pandemic, demand for Hammond’s components surged due to a a rise in electric vehicle charging stations, factory onshoring, and data centres.
Since 2021, Hammond Power’s stock has surged from $9.11 to $209.50. That makes for a 2,196% gain! If you add in dividends, its total return is closer to 2,416%!
Had you put $7,000 to work in Hammond Power stock in early 2021, it would be worth over $161,000 today! That’s a $154,000 gain if sold today. If that was not in a TFSA, you could be liable for a $37,000 tax bill. Inside the TFSA, the entire gain is yours.
An industrial stock that turned $7,000 into $164,000
TerraVest Industries (TSX: TVK) is another mid-cap stock that could have rapidly multiplied your TFSA capital. Like Hammond, this was not an exciting business.
TerraVest manufactures boilers, HVAC units, pressurized tanks, trailers, and energy components. The key to its success was likewise a low valuation, wise capital allocation, and a large opportunity to grow.
This company finds mom and pop manufacturing businesses, acquires them at attractive valuations, and then uses its scale and operating expertise to maximize cash flows.
Over the past five years, revenues have compounded by a 33% annual rate. Earnings before interest, tax, depreciation, and amortization (EBITDA) grew by a 37% compounded rate. In 2021, it had a price-to-earnings ratio of only 12. Today, its price-to-earnings ratio is over 30.
Over the past five years, TVK stock is up 714%. Over the past 10 years, its stock has risen 2,249%. Add in dividends and its total return over the decade is closer to 2,950%!
If you put $7,000 into TerraVest in 2016 (10 years ago), that investment would be worth over $164,000 today. That is a $157,000 gain. By keeping that stock in a TFSA, you would have saved over $37,000 in potential tax obligations owed outside the account.
The TFSA bottom line
Both of these stocks continue to be good businesses. However, their valuations have greatly increased, so they may not have the same torque as in past years.
Foolish investors should look for similar type stocks in their early stages of growth and at attractive valuations. Buy them and hold them in a TFSA, and you can really enjoy the benefits of tax-free wealth creation.
