Wednesday, July 9, 2014

Look abroad for higher dividend yields

US stocks these days are offering much lower yields than the rest of the world. For example, S&P 500 yields less than 2%, while UK stock indices are yielding more than that. Given the fact that foreign companies are paying more generous dividends that US ones, should dividend investors venture abroad?

Before investors decide to invest in foreign stocks, they need to understand the risks and peculiar characteristics of foreign dividend paying stocks.

In general, most foreign dividend paying companies pay fluctuating dividends each year. Foreign companies are quick to cut dividends if earnings fall even by a small amount, since they target a particular dividend payout ratio, rather than a particular level of dividend payments. US investors who are used to the stability of dividend payments that most American firms exhibit might be disappointed by this feature. Fluctuating dividends make it particularly difficult to live off your investments, and as a result it is best that these companies are avoided.

Adding to the injury, most foreign companies tend to distribute cash to shareholders once or twice per year at best. Many multinationals such as Nestle (NSRGY) for example pay distributions once per year. As a result, investors who like to reinvest dividends have only one instance/year to compound their profits. As a dividend investor, I have found that having the ability to reinvest the same annual dividend in four quarterly installments allows for faster compounding than having the dividend compound just once per year. For the companies that pay dividends twice annually, they tend to split distributions into interim and final payments. The interim payments typically represent 40% of the total annual dividend, while the final payment represents 60% of the total annual dividend. As a result, many US services such as Yahoo!Finance, routinely miscalculate the dividend yields of companies such as UK based company Diageo (DEO), or Vodafone (VOD).

Another factor to consider before purchasing foreign shares is taxes. Many countries such as Canada, France, Switzerland and Netherlands, to name a few, impose taxes on dividends paid out to US investors. These taxes are typically around 15% for Canadian stocks held by US investors for example. While US investors can claim a credit for any taxes withheld at a foreign source in taxable accounts, they cannot do that in tax-deffered ones such as ROTH IRA’s. In addition, some foreign companies such as Unilever have dual class shares with similar rights that trade both in London and Amsterdam. Purchasing the Netherland based ADRs for Unilever N.V. (UN) could lead to tax withholdings, whereas purchasing the United Kingdom based ADR’s for Unilever PLC (UL) could pose no such problems. US dividend taxes would still be due of course, but there is less paperwork trying to claim foreign taxes withheld on dividends.

Another factor to consider includes transaction costs. Many US investors tend to purchase American Depositary Receipts (ADRs) on foreign listed shares. As a result, they end up paying US capital gains taxes and US commissions. If you dare to venture abroad however, you would have to deal with finding the right broker, paying taxes abroad and paying commissions which are probably much higher than the ones in USA.

In general, many foreign companies also report results under IFRS, which is a different accounting standard than the US GAAP. Other factors to consider include the fact that many foreign companies listed in the US are typically global businesses, and therefore would trade similarly with their US competitors. In other words, during the financial crisis of 2007 – 2009, many stocks lost almost half of their values. As a result, venturing out abroad might not have delivered the diversification benefits that international investing is supposed to deliver. However, by expanding the time-frame to look at performance of foreign shares before and after the crisis, one could note a few differences. Because of the global nature of business these days, I avoid international over diversification by purchasing shares of US based multinationals.

There are a few lists with dividend growth stocks, which could aid investors in their search for dividend paying companies with dependable and rising distributions. These include the international dividend achievers index, which lists companies traded in US, which have boosted distributions for at least 5 years in a row. Another interesting benchmark is the Europe Dividend Aristocrats index, which lists European companies which have raised distributions for over 10 years in a row.

Some foreign companies that fit in this criteria include:

Diageo (DEO), which produces, distills, brews, bottles, packages, and distributes spirits, beer, wine, and ready to drink beverages. The company has managed to increase dividends for at least 15 years in a row. Currently, the stock is selling for 19.70 times forward earnings and yields 2.70%. Check my analysis of Diageo.

Nestle (NSRGY), which provides nutrition, health, and wellness products worldwide. The company has managed to increase dividends for 18 years in a row. Currently, the stock is selling for 18.60 times forward earnings and yields 3.10%. Check my analysis of Nestle.

Novartis (NVS), which is a multinational company specializing in the research, development, manufacturing and marketing of a range of healthcare products led by pharmaceuticals. The company has managed to increase dividends for 17 years in a row. Currently, the stock is selling for 17.50 times forward earnings and yields 3%. Check my analysis of Novartis.

Unilever (UL), which is a consumer goods company operating in Asia, Africa, the Middle East, Turkey, Russia, Ukraine, Belarus, Europe, and the Americas. The company has managed to increase dividends for at least 19 years in a row. Currently, the stock is selling for 20.20 times forward earnings and yields 3.50%. Check my analysis of Unilever.

BHP Billiton (BBL), which operates as a diversified natural resources company worldwide. The company has managed to increase dividends 15 years in a row. Currently, the stock is selling for 16.80 times forward earnings and yields 3.50%. Check my analysis of BHP Billiton.

Those companies are a little pricey today, but are good long-term holdings for long-term investors. If prices decrease from here, it would be nice to have those company on a watchlist.

Full Disclosure: Long NSRGY, UL, VOD and DEO

Relevant Articles:

International Over Diversification
Best International Dividend Stocks
International Dividend Stocks – Pros and Cons
Nine Quality Dividend Stocks Purchased for the Roth IRA
How to retire in 10 years with dividend stocks

7 comments:

  1. DGI,
    Nice list. I had a Canadian bank stock in my 401k and got hit with the 15% withholding on the dividend. Ended up selling the stock and buying AFL for the reasons you stated. I currently own UL, but have been watching DEO and NSRGY.
    Thanks,
    KeithX

    ReplyDelete
    Replies
    1. Hi Keith,

      US brokers are not supposed to withhold the 15% Canadian Dividend Tax in US Tax-Sheltered accounts like IRA's for example, because of treaties between US and Canada. Some like Sharebuilder still withhold the money they are not supposed to withhold, and they do not want to make the change, since it will be costing them money. Unfortunately, I have not found a broker to keep Canadian shares in tax-deferred accounts, without paying the penalty.

      I like DEO, since it is much cheaper than the likes of Brown-Forman or BEAM (although BEAM is being acquired now).

      DGI

      Delete
    2. DGI,
      Our company 401k is held by Merrill Lynch, and they just deduct the 15% from Canadian banks. I have found arguing with them to be a waste of time in the past, but maybe I'll give them a call on this and see what happens.
      Thanks,
      KeithX

      Delete
    3. I was wondering why I had tax withheld (I am in ShareBuilder). Anyways I try to avoid foreign stocks now as well although my stock screen usually has a few in it.

      Delete
  2. As you say, taxes on foreign investments is definitely something that you will need to consider if investing in foreign stocks. I'm based in the UK and I had bought shares in AAPL recently in a non-tax wrapped account, but sold fairly soon after when I fully understand the extent of the admin burden for taxation and withholding tax on dividends etc..

    ReplyDelete
  3. Funny, I'm in Sweden and I'm looking abroad to the US trying to find stocks, haha! Our stocks usually have better yield than US stocks, but I don't think our companies are comparable to US aristocrats.
    Interesting about the tax situation. I also pay 15% foreign tax but can deduct my local taxes so its actually zero.

    ReplyDelete
  4. The Registered Retirement Savings Plan accounts in Canada allow us to invest in American stocks without worrying about withholding taxes. It's unfortunate that the reciprocal provision is not being provided for you. However, one of the advantages you have of living in the U.S. is the large number of foreign based stocks that are listed on the NYSE. Many are ADRs and as such you may have tax issues that. But many are not. In particular, there are 152 non-ADR Canadian stocks cross-listed on the NYSE. Most of these stocks are also listed on the TSE or TSE-V but trade separately in the U.S. Would non-ADR foreign stocks incur a withholding tax? I don't know.

    Some of the Canadian dividend growth stocks available are:
    the banks, e.g.:Bank of Montreal (BMO), CIBC (CM), Scotiabank (BNS),
    the comms oligopoly; Telus (TU), Bell (BCE), Rogers (RCI)
    lots of mining and materials stocks.
    The full list for the NYSE is here:
    https://www.nyse.com/publicdocs/nyse/data/Current_List_of_All_Non_US_Stocks_05-31-14.pdf

    I am long or plan to be long in all of the areas mentioned above, if not necessarily each stock.

    I recently purchased Seagate for my portfolio. I was surprised when I noticed the withholding tax on the dividends as I did not realize it was an ADR.

    ReplyDelete

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