Currency, Foreign Stocks and Dividends

The popularity of foreign stocks ebbs and flows, but there’s always someone on TV touting them for either growth or diversity. I have owned a few large-cap foreign stock ADRs (American Depository Receipts) from time to time, but none presently. I would like to relate some of the nuances that I experienced. I never owned any foreign stock ETFs or mutual funds, but the discussion can easily be applied to them as well.

ADRs are issued by depository banks and trade on US exchanges in US dollars. The depository banks distribute the dividends from foreign stocks into US dollars, extracting a fee from the shareholders annually when not reimbursed by the foreign company. The fee shows up as debit on your brokerage statement at the same time the dividend is posted. Additionally, you will see a debit for foreign taxes related to the dividend, even if the ADR resides in a tax-free (Roth IRA) or tax-deferred (Traditional IRA) retirement account. Luckily the fees and taxes have never been greater than the dividends for me.

ADRs represent either a multiple or fraction of the ordinary (common) shares of foreign companies. Arbitragers keep the price of the ADRs in line with the ordinary shares and the currency exchanges rates. This gets far more complex with foreign ETFs which often trade at large premiums or discounts to net asset values.

Let’s look at how currency affects ADR pricing and dividend yields. For simplicity I am assuming that the foreign companies are growing at similar rates to the US companies and stock price appreciation is on par. A stronger dollar would price an ADR lower relative to the ordinary shares, given that one dollar buys more foreign currency. A weaker dollar would conversely raise the price of the ADR relative to the ordinary shares.

When the dollar is weak and you predict it is getting weaker, you’ll start out overpaying for ADRs, but they could continue to increase in price. If the dollar strengthens and the ordinary shares don’t increase enough in value, you could lose money.

ADR dividends behave similar to ADR price, but dividends don’t have the advantage of increased expectation of ordinary share prices. When the dollar weakens, ADR dividends increase due to dollar translation. Conversely, when the dollar strengthens, ADR dividends decrease. Absolute yield will then depend on the price behavior of the ordinary shares.

Foreign large-cap stocks typically pay dividends only once or twice a year, and the dividends are high relative to US stocks. This makes yields deceiving if the prior dividends are not adjusted for currency in real-time. Also, most foreign dividends are not fixed as the US. Foreign dividends are often based on a percentage of profits and companies must actually make a statutory profit in order to be allowed to pay dividends.

As a general rule it is better to buy foreign stocks and ETFs when the dollar is strong, unless you are a closet currency trader or are especially knowledgeable in foreign companies and economies.

GlaxoSmithKline (GSK) and Taiwan Semiconductor (TSM) are examples of ADRs.

Comments

[JAGGSS:]

The author is correct on every count regarding ADRs. However, the cross border areas that are discussed in this article represent conditions that are a result of normal market currency dynamics. Whereas ADRs represent a greater variety of consequences to the unsuspected global investor regardless of the classification of security a shareholder retains. For example, as long as an ADR program exists, the shareholder of either the ADR or ordinary share of Glaxo or Taiwan Semiconductor face the exact same consequence.

Nov 06 09:52 AM

[David Van K...:]

The author may be technically correct, but a couple of statements are misleading:

"[D]ividends don’t have the advantage of increased expectation of ordinary share prices." Share prices go up or down no matter the market or country of origin of the stock. Also, well-chosen dividend stocks do have an expectation of rising dividends, whether the stock is foreign or domestic. Indeed, this expectation is often a principle reason one buys a dividend stock.

"Foreign large-cap stocks typically pay dividends only once or twice a year, and the dividends are high relative to US stocks." This is an overgeneralization. Foreign stocks can be on any sort of dividend-payment schedule, just as domestic companies. And their dividend isn't typically higher than U.S. stocks. Foreign companies pay dividends of all sizes, from zero to very high yield, just as domestic companies do.

"Also, most foreign dividends are not fixed as the US." Dividends are not fixed in the U.S., they come from periodic decisions by companies to distribute some of their profits to shareholders in the form of dividends. Sometimes dividends are cut, other times they are increased. I think the author means that, by common practice, U.S. corporations tend to hold the dividend steady for, say, three consecutive payouts, then they change the payout once per year, whereas many foreign corporations tend to let their payouts "wander" from quarter to quarter depending on their profits that quarter (or half-year). But some domestic companies do that too. The thing to look for is annual total payouts: Does the company (foreign or domestic) have a history of increasing its annual payout each year? Look for that no matter what the frequency or consistency of individual payouts may be within each year.

Nov 06 04:08 PM