By Nanette Byrnes
In recent debate over our piece on the tradeoffs of investing in dividend stocks in place of bonds, there was quite a lively discussion around investing in global dividend stocks. Much of it along the lines of "How come no one ever writes about income investing outside the US?"
The preferred choice for many is to invest in some of the many US-based dividend payers that earn a lot of their revenue overseas -- Philip Morris International (PM) is legally headquartered in New York but gets 100% of its revenue selling Marlboros and other tobacco products outside of the 50 States. Its yield is currently 4.4%. Companies in the Standard & Poor's 500 index on average got just under 30 cents of every dollar of 2009 revenue overseas, according to Bespoke Investment Group. Goldman Sachs predicts the index will yield 2% in 2011.
But there are also plenty of global companies trading on American exchanges through ADRs that offer good dividends, as well as ETFs and mutual funds focused on foreign dividend stocks.
Some foreign stocks pay big dividends.
The attraction of some of these stocks -- besides whatever business fundamentals they boast -- is uncommonly high yields. According to Factset data, as of December 31, 2010 the dividend yield for the MCSI EAFE, an index of developed market firms outside the US and Canada, was 2.93%, compared to 1.86% for the US-focused S&P 500. A recent list found 25 global stocks over 5% yield including 3 over 7% -- France Telecom (FTE), Germany's Electrical Utility RWE AG (RWEOY.OK) and Brazilian Utility CPFL Energie (CPL). One stock, Australian Telecom Telstra Corp. (TLSYY.PK), has a yield of over 9.7%.
Judy Saryan, a portfolio manager for several Eaton Vance dividend mutual funds, thinks more investors are going to grow interested in foreign dividend-paying stocks as their strengths become better known:
The yield on many European equity markets is greater than it is for ten-year U.S. Treasuries and for their respective sovereign debt yields. We anticipate increased investor demand for alternate sources of income, which bodes well for high-yielding European equities.
After the financial crisis in 2008, many investors' focus shifted from capital appreciation to capital preservation and income. As investors continue to search for income that has the potential to outpace inflation, we believe that foreign dividend paying stocks may become more popular.
For US investors, Sarayan says, global dividend stocks offer a diversification of currency exposure, combined with generally higher yields and relatively cheaper stock prices. Plus they give you a shot at growth outside the US and lessen your exposure to US risk. Any company increasing dividends, Sarayan argues, has fiscal discipline, and the cash on hand to pay that dividend out, leaving "no opportunity for creative accounting or questionable financial reporting practices."
Dividends too can provide some stability in volatile markets:
Historically, dividend growth has outpaced inflation, so dividend-paying stocks can be a very attractive alternative to fixed income securities in a rising rate environment. Investors receive income without duration risk with dividend-paying stocks. In the 1970s, the most recent example of an extreme inflationary environment, the growth in dividends per share paid on the S&P 500 outpaced inflation.
Foreign Dividends Not As Predictable
There are some differences and possible drawbacks to foreign dividend investing, however, including: foreign currency risk, irregular dividend payments, and differences in accounting standards or corporate financial reporting that may make it tougher for an investor to research.
Rather than paying dividends quarterly, it's common for companies outside the US to pay once or twice a year. That impacts the compound growth of your money if you're a dividend re-investor, and also might not suit people using their dividends to fund current expenses.
The dividend of a foreign company isn't always as reliable as that of a US firm. Many overseas companies pay dividends equal to a percent of earnings, making them more volatile than in the US where a record of steady or increasing dividends is prized. In a post on this topic from 2009, the blog Dividend Growth Investor describes the cultural differences behind that:
The dividend payments of foreign dividend stocks closely follow the earnings trend for the corporation. This is a problem for international dividend growth investors as it does not lead to a consistently increasing dividend income stream, which they are used to by investing in US companies. In the US companies are reluctant to cut dividends if the company had a bad year, while in Europe the dividends are more likely to be cut in response to short term fluctuations in earnings.
Some companies do pay regularly. The International Dividend Achievers is a list of stocks that have increased their annual regular dividend payments for the last five or more consecutive years. There are 77 companies in the index and it's done pretty well (click to enlarge):
Foreign dividends somewhat complicate your taxes. Foreign taxes will be withheld from your dividends. You can get a credit for that against your US taxes, though.
No Free Lunch
No matter how you invest, you'll need to do some homework. If you're buying individual stocks, of course you'll need to get comfortable with those businesses. But even if you're buying an Exchange Traded Fund you'd be wise to do a little peeking under the covers. Dividend ETFs as a broad class is the fastest growing group of the now $1 billion ETF world, but some are fretting their dividend payouts may not be so stable. The answer: be sure you know what's in any ETF you buy.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.