Dividend Growth Investing And Foreign Companies

by: PriusBob

A Superior Dividend Grower (SDG) is a company that consistently increases their yearly payouts by 8% - 10% per year. Such companies are usually found among the largest, most global, stable companies.

Where are the Largest, Most Stable Companies?

In 1980, a list of the 100 largest companies in the world showed that just more than half were originally domiciled in the US. Thirty years later, the same list of the largest companies in the world showed that the proportion of US origin companies had dropped well below 50%. There are lots of different lists of the "largest" companies in the world, using various metrics for the word "large". However, the trend over the last 30 years is the same. More and more of the largest, most global and most stable companies are domiciled outside of the US.

Given the trend toward the largest, most stable companies being foreign (especially Asian), any dividend growth portfolio will have to focus more and more on foreign companies to create safe, growing income streams, if high income growth rates are desired. Finding, evaluating and acquiring foreign SDGs will have various implications, which will be discussed below. A future article will explore several ways to access, evaluate and buy high dividend growth stocks of foreign companies.

Foreign SDGs and the Dollar

Given the fact that the largest, most stable, most global companies are tending to be foreign, there is an automatic diversification away from the dollar. Each individual dividend growth investor must decide if this is a good idea. The dollar's relationship to other currencies may not change much over the next several decades. However, if the dollar will tend to become a bit weaker over the long term, this diversification away from the dollar will have been prudent. On the other hand, if the dollar tends to strengthen over the same number of years, being paid in other currencies will not be as lucrative.

If the value of the dollar lessens when compared to a basket of other relevant currencies, then the corresponding basket of dividends would be increasing, since they would tend to buy more dollars. The reverse is also true, i.e., if the value of the dollar increases when compared to the same basket of relevant currencies, then the associated basket of dividends would be decreasing, since the dividends would tend to buy fewer dollars. Global trends with regard to these currency relationships are difficult to predict.

Current dividend growth portfolios that seek the highest dividend growth combined with low risk will have a slight tendency to diversify away from the US dollar. This portfolio tendency is projected as increasing in the future, since dividend growth investing involves finding safe, growing dividends on a global basis, and companies with such dividends may tend to be foreign. Each investor must decide if this is a good thing, or not.

The Willingness to Pay Dividends

Generally, the dividend payout practices of foreign companies are "superior" to those of domestic companies, in the sense that they pay out a greater proportion of their earnings in dividends, they tend to have higher yields due to lower PE ratios, and the share buyback level of these companies is somewhat low.

The London FTSE All Share index has yielded 3% or better since 2009. In 2011, the average dividend yield of the MSCI All Country Asia Pacific index (which includes Japan) has been around 3% also. This has been true while the S&P 500 yields have been very close to 2%.

Foreign companies generally pay out excess cash in the form of dividends. The tendency in the US, especially prior to 2008, was to return more excess cash in the form of buybacks instead of dividends. The popularity of buybacks as a way to return cash to shareholders is not quite so popular outside of the US.

The future trends in payouts and buybacks involving foreign companies are difficult to predict. There are also issues of transparency and the validity of reported financial metrics. Other issues that negatively affect the payment of increasing dividends by foreign companies include sovereign involvement, historically entrenched family ownership structures, corporate interconnected holdings, and other corporate structures that encouraged investment policies that were not supportive of paying increasing dividends to "minority" shareholders. All of these issues affect both the amount of excess cash flow available for dividends and the willingness to share such excess cash with "minority" shareholders.

If a foreign company looks as if it might quality as a SDG, all of the above macroeconomic issues should be taken into account before the company would be admitted to any dividend growth portfolio. Reliable information that could be used to address these issues may not be easy to obtain, but the questions should be asked, or at least kept in mind by the investor.

The Taxation of Dividends of Foreign Companies

This is a very complex topic and one where the rules change almost yearly, both with regards to US Tax regulations, and those of the country where the company is domiciled.

The rules for the tax treatment of foreign dividend income varies by (1) the country in which the dividends were "declared"; (2) the type of account (in the US) that held the security on which the dividend is paid; (3) the terms of any treaty between the US and the foreign country; and (4) where the shares of the foreign company are traded, i.e., on which domestic exchange, if any. The author does not keep track of all of these regulations, and quite a few tax attorneys seem to have trouble doing so also.

What Type of Account

If the dividend growth portfolio is held in a "qualified" account, i.e., in either a regular individual IRA or a Roth IRA, the portion of foreign dividends that are withheld by a foreign company cannot be recovered under current law. For some countries, and for some types of accounts, if they know that the holdings are in such a qualified account, the amount of the dividend withheld by the foreign country is different, and sometimes zero. Keeping up with the detailed provisions of withholding for each country and for each account type is difficult, to say the least.

If the dividend growth portfolio is held in a regular investment account or what is typically called a "taxable" account, then things become a bit simpler to understand and administer. What follows is a general attempt to explain the highlights of the issues, when the portfolio exists in a taxable account.

If a foreign company pays a dividend, most countries require a portion of the dividend to be withheld to pay taxes on this income. The rate of withholding varies by country, and sometimes by type of company within the country. If the country has a tax treaty with the US, or if the shares are traded on a major exchange as American Depository Receipts (ADRs), then the US allows the American taxpayer to "recover" these withheld taxes in either of two ways. First, the withheld tax amount can be taken as a deduction on the Itemized Deduction schedule, or secondly, the withheld taxes can be taken as a direct credit against one's tax liability.

The author keeps all dividend growth accounts holding foreign stocks in a regular taxable account, and recovers foreign taxes that may be withheld by foreign governments on his tax return. As the search for high growth dividends tends to emphasize foreign companies, it becomes more important to recover foreign dividends that are withheld, and therefore more important to restrict dividend growth portfolios to taxable accounts.

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.