Sorry, Your Dividends Are Not Coming Home Any Time Soon

by: Dale Roberts

In this article I looked at U.S. multinationals in consideration of those companies providing currency exposure. But perhaps the treatment of foreign earnings creates an even greater concern or threat to investors - cash available for their cherished dividend payments.

Large U.S. multinationals are increasingly generating earnings from their foreign operations. These multinationals now generate 40% of their profits from overseas. They are successful in nations such as China, India, Latin America, and much of South Asia, and Europe.

Here are a few examples:

Wal-Mart (NYSE:WMT): Total revenue: $420 billion. Portion from overseas: 26%; Exxon-Mobil (NYSE:XOM), $342 billion in revenue, 45% from overseas; General Electric (NYSE:GE), $149 billion in revenue, 54% from overseas; Bank of America (NYSE:BAC), $134 billion in revenue, 20% from overseas; Ford (NYSE:F), $129 billion in revenue, 51% from overseas; IBM, $100 billion in revenue, 64% from overseas; Amazon (NASDAQ:AMZN), $34 billion in revenue, 45% from overseas; McDonald's (NYSE:MCD), $24 billion in revenue, 66% from overseas; Nike (NYSE:NKE), $21 billion in revenue, 50% from overseas.

Profits are good and the source of dividends, I think we're all in agreement there? Until corporations can print money as governments do, they will have to create those profits and dividends the old fashioned way.

So naturally, dividend and dividend growth investors look at these growing earnings in growing regions and lick their chops. Well, they can put down those lobster bibs and knives and forks. The dividend feast will not be served, quite yet.

Here's the catch. That foreign cash pile, is not coming home. And what foreign profits are being repatriated is largely not being returned to shareholders in the form of dividends. You can complain to the tax man.

The hurdle is that U.S. companies cannot repatriate those earnings without facing significant taxes. To be more precise, U.S. companies cannot return those funds to shareholders, buy another U.S. company, invest in new domestic plants and buildings and equipment without facing (potentially) the top corporate tax rate of 35%. Ironically, they can repatriate those profits absolutely tax free if they invest in U.S. "assets" such as U.S. Treasuries.

Multinationals can bring home those profits to the U.S. (absolutely tax free) thanks to federal tax code, specifically Section 956(c)(2), if they invest those funds in other U.S. assets such as U.S. stocks other than their own, U.S. bonds, or U.S. mutual funds. The company must then pay taxes on any profit and income from those investments. Buying Treasuries - no tax. Paying dividends - full tax.

And of course, U.S. multinationals have no incentive to move that cash from a lower tax jurisdiction to a higher corporate tax jurisdiction such as the U.S.

If that same corporation uses foreign earnings to purchase a foreign business, no repatriation is required and no U.S. tax is due. As we know, many of the foreign countries in which these companies operate offer very attractive tax rates and other incentives.

This from More recently -- say, over the last decade -- it has become increasingly apparent that flaws in our international tax rules also play a significant role in hindering corporate distributions. As multinationals book an increasing share of their profits outside the United States, and the foreign effective tax rate on those profits drops, corporations cannot get large portions of their retained earnings into the country without paying large amounts of U.S. tax. If they do not return those profits to the U.S. parent, they cannot pay dividends to their shareholders.

What's more, it's a two way street, er make that ocean. U.S. corporations can move profits and income generating assets overseas. And once overseas they can move those profits into tax havens.

According to JPMorgan Chase, 60% of cash of U.S. multinationals now sits offshore. And Apple (NASDAQ:AAPL), touted as a future Dividend Machine leads the way.

JPMorgan Chase found that Apple had the highest offshore corporate cash balance, with $74 billion held overseas, representing 67% of its total cash holdings. But as a percentage of total cash, Apple had a smaller amount sitting offshore than many of its tech rivals, including Microsoft (NASDAQ:MSFT), Cisco (NASDAQ:CSCO), and Hewlett-Packard (NYSE:HPQ), which had 89% or more of their cash overseas.

Here's a look at Apple's cash that certainly falls far from the tree ...

(Click to enlarge)

Microsoft, General Electric, Cisco Systems, Google (NASDAQ:GOOG), and Oracle (NYSE:ORCL) had the next largest dollar amounts of cash held overseas, according to the study. The analysts also found that Johnson & Johnson (NYSE:JNJ) and Hewlett-Packard appear to have almost all of their cash holdings in overseas accounts. That's a worrying sign if U.S. multinationals are shifting a larger portion of their cash overseas, in some cases leaving the U.S. cupboard nearly bare. Imagine the dividend increases Johnson & Johnson could deliver if even half of their cash was staying home?

Dividend lovers, you might want to send those cash holdings a very thoughtful postcard, you might not be seeing them any time soon. In WWII, U.S. soldiers stationed in England were described as being overseas, overpaid and oversexed. Today, U.S. profits are overseas and … and … well, you come up with a witty finish to that saying and post it in the comment section. Those profits just might be taking up permanent (foreign) resident status.

The trend is the trend. And this time, the trend is not your friend. In 2009, sales by foreign affiliates of U.S. multinationals totaled $4,857.0 billion, up from $2,705.1 billion in 1999, reflecting a 6.0 percent average annual growth rate. In 1999-2009, the value added of foreign affiliates grew substantially faster (7.0 percent) than that of their U.S. parents (1.7 percent). That limp U.S. growth rate simply doesn't appear to support future compound dividend growth rates of 8-10%.

At the close of 2011 (the most recent period for which complete data are available), cash on non-financial corporate balance sheets had risen to more than $1.9 trillion - a jump of almost 60% from the dark days of 2008 and more than 50% from the last cyclical peak in 2007. Many dividend investors love hearing those kinds of numbers, but what's even more important is that those rising cash balances don't come with a U.S. zip code.

A Dharmapala, Foley, and Forbes study showed that when corporations were able to repatriate profits during a tax holiday in 2004, most of that money was returned to shareholders in the form of dividends and buybacks. That study reported estimates of between 60% and 92% of all repatriated profits being used for shareholder payouts. That's a frustrating fact for shareholders, knowing that the profits are there, and the money would likely end up in their pockets, if only more of it could find its way home.

Shareholders could use some of those foreign profits, and so could the U.S. government.

Corporations need to be paying more if the U.S. is ever going to fix its fiscal mess and put that deficit in a headlock and give it some noogies. Yes, I know that government spending (waste) is an even bigger problem, but taxation is a "problem" as well.

Currently corporate tax receipts as a percentage of GDP are near the lows of the last 50 years.

  • In the 1940s corporate tax receipts averaged 4.0%-7% of GDP
  • In the 1950s corporate tax receipts averaged 4.7% of GDP
  • In the 1960s corporate tax receipts averaged 3.9% of GDP
  • In the 1970s corporate tax receipts averaged 2.7% of GDP

From 1985, here are the corporate tax receipts as a percentage of GDP:

Year Percent of GDP
1985 1.5%
1986 1.4%
1987 1.8%
1988 1.9%
1989 1.9%
1990 1.6%
1991 1.7%
1992 1.6%
1993 1.8%
1994 2.0%
1995 2.1%
1996 2.2%
1997 2.2%
1998 2.2%
1999 2.0%
2000 2.1%
2001 1.5%
2002 1.4%
2003 1.2%
2004 1.6%
2005 2.2%
2006 2.7%
2007 2.7%
2008 2.1%
2009 1.0%
2010 1.3%
2011 1.2%
2012 1.5% (est.)

Certainly recessions kill corporate profitability and government tax receipts. But we're not seeing a very robust return of corporate tax payment coming out of 2008. Corporations have had a decent run in the low growth recovery out of the Great Recession, but those tax receipts just ain't showing up. The rising profit streams are largely overseas, and U.S. profits are holidaying overseas as well.

And as we can see corporations have been getting better and better at giving the tax man the slip. Receipts are now about 1/3 to 1/4 of what they were in the 40s through 70s.

And heading into 2013 we just might be moving even further in the wrong direction.

Obama and Co. are looking to grab more cash from Corporate America Co. and the "rich" Americans, and he's looking to raise taxes. The problem is, obvious to many, but not to all, that raising taxes on corporations delivers "unintended consequences." The more corporate taxes are raised under the current corporate tax regime, the more corporations will slip out the side door with those profits.

Sensible and competitive tax rates for corporations and a lower and sensible dividend tax rate would likely increase corporate taxes collected, as well as increase dividends paid, and overall taxes collected from those dividend payments.

The takeaway

The two big numbers that stand out for me, are that (1) - 40% of profits are being created overseas. And (2) - 60% of the multinationals' cash is sitting overseas. And those trends are accelerating.

And of even more concern, some multinationals (and popular dividend champions) are holding almost all of their cash overseas.

Some may read that and think, that's a nice problem to have, lots of cash floating around the world. And certainly the dividend paying companies know that they have a responsibility to shareholders who own their companies largely for the dividend payouts, and dividend growth.

But moving forward, Dividend Growth investors might have to be satisfied with capital gains (the antithesis to the investment philosophy) as those cash balances drive share price and not dividend growth. Dividend investors might have to learn how to hit that sell button.

How this plays out is up to the lawmakers in Washington. And if the trend is the trend, we can likely count on them to get it wrong.

With the intent of generating more tax revenue, U.S. lawmakers will likely continue "pushing on string."

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Disclaimer: Please note that Dale Roberts aka cranky, the crankywriter, the scaredy cat investor is not a licenced investor advisor, and the above opinions should only be factored in to an investor's overall opinion forming process. Consult a licenced investment advisor before making any investment decisions. Please. Dale Roberts has positions in the companies listed through the holding of an ETF listed on the Toronto Stock Exchange.