Being able to make money without lifting a finger is a dream that many Canadians don’t fully realize how easy it is to achieve. There are plenty of ways to generate passive income in Canada. With the right tools and using the right investments in the best retirement accounts, you can even make that additional income tax-free.
The Tax-Free Savings Account (TFSA) is an incredible account type introduced in 2009 to encourage Canadians to improve their savings habits. The account essentially lets you contribute to it with after-tax dollars. This way, you can enjoy any returns on holdings in the account without incurring taxes.
For any cash you hold in the account, this means no taxes on the interest income. However, using the TFSA to hold cash alone is a waste of space in my opinion. You can use the savings account as an investment vehicle and get more out of it. Any returns on stocks held in the account will also be tax-free. This means you can enjoy tax-free dividends and capital gains.
A monthly dividend-paying stock like Freehold Royalties (TSX: FRU) might be an excellent example to consider.
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Freehold Royalties
Freehold Royalties is a $2.88 billion market-cap loyalty income trust that is in the business of acquiring and managing oil and gas royalties. The trust offers you the chance to leverage the performance of an income-generating asset with strong margins and lower exposure to risk in an otherwise higher-than-usual-risk industry. This Canadian energy sector royalty income trust is a favourite of mine. As of this writing, it trades for $17.54 per unit, paying investors $0.09 per share each month, translating to a juicy 6.15% annualized dividend yield.
Freehold isn’t a typical energy stock. The company isn’t directly involved in producing crude oil and natural gas, unlike most energy stocks trading on the TSX. The company does not make money by spending time and capital on setting up drilling rigs, wells, and pipelines. Neither does the company generate revenue by transporting crude and gas for oil producers. Instead, it generates revenue by providing others access to its assets.
The trust owns over seven million acres across Canada and the U.S. across shale basins and conventional oil regions. Its counterparties use the land to extract resources from it, paying the trust a portion of what they generate from the land. Freehold is a pure-play royalty business. This means the company has no overheads that energy companies typically face.
Without operator costs, Freehold enjoys significantly greater margins and only collects its share of the production revenue. In turn, this can mean a much better ability to deliver returns to investors who own shares of the trust. You don’t see energy stocks posting margins of around 51%. The royalty model gives Freehold Royalties this benefit, which benefits its investors as well.
Foolish takeaway
Freehold Royalty has an excellent management team that targets a payout ratio of around 60% of its free cash flow. This helps the company keep its monthly payouts to investors sustainable by creating a buffer when oil prices fluctuate downward. While that means the returns won’t be significantly greater during periods of boom for oil prices, it also protects investors from downticks in oil prices.
If you seek a reliable dividend stock that pays each month for your self-directed TFSA portfolio, I would consider giving Freehold Royalties a serious thought.
