While I maintain that dividends should still be one of the primarily focuses of investors looking for stable returns in today's market, there are a few problems that could arise. If you own a brokerage account in the U.S., you are being paid your dividends in U.S. dollars.
If the U.S. dollar appreciates, American businesses with large overseas operations will have significantly reduced profits. For instance, let's take McDonald's (MCD). According to the company, consolidated operating income in Europe increased 8% in Q1 2012 relative to 2011 when using constant currency, but strength in the U.S. dollar -- and weakness in the euro and pound, among other foreign currencies -- brought the figure down to 4%.
With the recent Federal Open Market Committee announcements on June 20, 2012, we have confirmed that the Federal Reserve is not going to create a third quantitative easing program anytime soon. We did get an extension of Operation Twist, although the impact of this program with regard to the U.S. dollar in the foreign exchange market is almost negligible given that the "Twist" was expected. This has led many investors to believe that the appreciation of the U.S. dollar will continue, verifying signs of deflation that are implied in U.S. Treasury bill yields.
Below are five dividend stocks that may be susceptible to any significant increases in U.S. dollar strength. Theoretically, if earnings were impacted enough, these companies would have to slow down or halt their dividend hikes.
Group A: American Multinationals
This group contains U.S. companies that derive disproportionate amounts of revenue from countries outside the U.S.. The earnings weakness would arise when their foreign profits have to be converted into U.S. dollars -- if the dollar is too strong, the number will be smaller than expected.
1. McDonald's (MCD)
As mentioned earlier, the fast-food behemoth McDonald's could have problems. About a third of the company's revenues come from the United States, with roughly 40% coming from its largest market -- Europe. Asia is its fastest growing region, and China is the focus. This makes McDonald's particularly vulnerable to the value of the Renminbi as more time passes. The stock yields 3.1% on a payout ratio of approximately 48%.
2. Intel (INTC)
Semiconductor giant Intel has had outstanding earnings growth over the last few years, but there is no denying its vulnerability to foreign markets (and hence currencies). Based on its latest 10-K filing, the firm only earns 21% of its revenue from the Americas. Over half of its revenue is from Asia. Intel shares also yield 3.1% on a low payout ratio of ~33%.
3. Dupont (DD)
Being one of the world's largest chemical companies, DuPont does have heavy exposure to foreign markets. Percentage-wise it's not nearly as vulnerable as Intel (DuPont earns about 43% of its revenue from North America), but the fact that the majority of its business is international raises a few concerns. The stock yields about 3.4% on a ~45% payout ratio.
Group B: Energy Giants
These two companies are doubly exposed to U.S. dollar strength because they benefit from higher oil and gas prices. A strong dollar not only cuts into foreign earnings, but it also causes the market to keep a tight lid on crude oil and natural gas prices. This would eventually cut into these companies' margins since most of their money comes from oil production.
1. Exxon Mobil (XOM)
Only 13% of Exxon's upstream profits are derived from the United States. Since these upstream (oil-producing) operations bring the bulk of the company's income, it can get slammed by U.S. dollar strength. The bright side is that the 2.7% yield on shares is relatively safe, since the payout ratio is only 22% or so.
2. Chevron (CVX)
According to its latest quarterly report, 25% of Chevron's upstream income is made within the United States. This makes the company a bit less exposed than Exxon. In addition, the dividend yield is a bit higher (3.5%) and the payout ratio is almost identical. Based on the context provided in this article, Chevron is an better pick of the two energy names.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.