Why Dividend Investors Should Love These 5% Yielding European Stocks

Summary

• U.S. stocks are still rallying, which has pushed down dividend yields. However, European stocks offer much higher dividend yields, in many cases well above 5%.
• GlaxoSmithKline, BP, and Royal Dutch Shell are each struggling right now for various reasons, which has kept their valuations low. But this has also kept their dividends very high.
• And, each company generates enough profits to sustain their sky-high yields. For income investors frustrated with paltry yields on U.S. stocks, take a closer look at Glaxo, BP, and Shell.

The U.S. stock market averages recently touched a new all-time high. As stock prices are rising, dividend yields are falling, since price and yield are inversely related. This leaves income investors in a tough spot, which leads many, including myself, to believe that bargains are hard to find among domestic stocks.

However, this isn't necessarily the case when it comes to global stocks. European equities are far more attractive than U.S. stocks right now, because stocks there are far cheaper than their U.S. counterparts. Of course, there is a reason for this, which is that economic growth remains very weak throughout Europe, due to a number of factors including the financial crisis in Greece.

But there remain a number of highly profitable European companies that have a global reach, and as a result are still generating strong cash flows. Even better, they pay very high dividend yields, in many cases far higher than the yields available in the U.S.

Specifically, I believe income investors should love GlaxoSmithKline (NYSE:GSK), BP plc (BP), and Royal Dutch Shell (RDS.B).

1 in Big Pharma, 2 in Big Oil

As previously mentioned, while U.S. stocks are roaring higher, European equities have stood relatively still. The good news is that this has left plenty of bargains available for income investors who can't find many dividend opportunities here.

GlaxoSmithKline is a diversified health care giant with a dividend that yields well over 5%. This is very attractive in itself, since many in its peer group offer yields at about half that. For example, Bristol-Myers Squibb (BMY) yields just 2.2%.

Glaxo has had some fundamental challenges that have suppressed its valuation. First and foremost is the loss of exclusivity for one of its key drugs, Advair. Because of this, earnings per share fell 16% last quarter, year over year. But Glaxo has a balanced business across three key categories: Pharmaceuticals, Consumer Health, and Vaccines. In fact, Glaxo now has 10 products that each generate at least 500 million pounds (approximately $783 million) each year.

Glaxo is struggling in pharmaceuticals, where Advair declines caused total sales to fall 7% last quarter. But strength in other areas helped offset this. Within the pharmaceuticals group, Glaxo grew revenue in HIV by 42%. In Consumer Health, revenue grew 24% year over year, thanks largely to the launch of over-the-counter Flonase. Lastly, Vaccines revenue grew 10%. Going forward, Glaxo should return to growth soon, thanks to its robust pipeline. Glaxo now holds 40 products in phase two or three development.

Separately, two European energy stocks offer significantly higher yields than their American peers. BP and Royal Dutch Shell currently yield 5.6% and 5.5%, respectively. This yields are extremely attractive relative to the U.S. majors like Exxon Mobil (XOM), which yields just 3.3%.

Of course, BP and Shell are struggling because of the massive drop in oil prices over the past year. But they still generate healthy cash flow, like their U.S. based competitors, thanks to their integrated structure. BP and Shell hold large downstream businesses, where profits have actually improved thanks to the oil rout. This is because, when oil prices are volatile, refining margins widen. In addition, lower oil prices help reduce feedstock costs.

As a result, BP and Shell are still generating enough cash flow to sustain their dividends. For example, BP's first-quarter profit fell 18% year over year, to $2.6 billion. Not surprisingly, the exploration and production business crumbled due to falling oil prices. Upstream profits collapsed 86% year over year. Fortunately, some of this was offset by downstream, where profits more than doubled, to $2.2 billion. Moreover, BP was boosted by a surprise $200 million profit from its nearly 20% investment stake in Russian energy giant Rosneft, while analysts expected BP to post a loss from its Rosneft stake.

For its part, Royal Dutch Shell suffered a 56% drop in first-quarter earnings per share. Not surprisingly, upstream profits collapsed by 88% year over year. However, similarly to BP, Shell's downstream profits rose 68% to $2.6 billion.

Going forward, investors should feel comfortable that BP and Shell can continue to pay their hefty dividends. Both Shell and BP are taking necessary steps to keep their dividends intact during such a difficult climate. Primarily, they are turning to asset sales and capital expenditure reductions. Shell's asset sales totaled $2 billion so far this year. Also, the price of oil has risen significantly off its 2015 lows. Brent crude futures are up approximately 20% since the end of March. This will be a big help to BP's and Shell's fundamentals in future quarters.

Global Reach, Industry-Leading Yields

While U.S. stocks enjoy lofty valuations, their dividend yields are down significantly. The S&P 500 offers just a 2% yield on average. By comparison, European equities are looking far more attractive to income investors, because many carry much higher yields. In two particular sectors, health care and energy, European stocks Glaxo, BP, and Shell offer the highest yields.

Europe is struggling with a weak economy, but Glaxo, BP, and Shell are huge companies with operations that extend across the globe. They are not solely contained to Europe. In addition, even though their businesses are hurting for various reasons, they still generate enough profits to sustain their dividend yields, which are above 5%. Income investors should take a closer look at these three high-yield European stocks.

Disclosure: The author is long BP, GSK. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.