Thursday, October 8, 2015

A Costly Misconception about foreign dividend stocks

There is a misconception about foreign dividend stocks which can cost you thousands of dollars of lost dividend income. I see this misconception so frequently when I interact with dividend investors, that I have decided to note it, and end it once and for all.

Let's look at the dividend payments from a few companies in US dollars and local currency.

The first company is Nestle (NSRGY), a global dividend powerhouse which has managed to boost dividends in Swiss Francs (CHF) for 19 years in a row. You can see that since 2001, the dividend payment in Swiss francs has been up.


If you look at the payment in US Dollars however, you would think that dividends were cut in 2009 and 2015.



I will also illustrate the same concept using Diageo (DEO). The company has managed to increase dividends every single year since 1998 in British Pounds.


If you look at the annual dividends paid in US Dollars, you could see a much different picture. If you only looked at the dividends in US dollars, you would have believed that the dividend was cut in 2008 and 2009. The reality is that in 2008 and 2009 the British Currency weakened against the US dollar.


Many investors are aware of the benefits of international diversification, as well as some of the cons such as the negative wealth effect of foreign withholding taxes. However, anytime investors focus on shares of international dividend powerhouses like Unilever (UL), Diageo (DEO), or Nestle (NSRGY), they somehow forget that these companies are headquartered outside of the US. Therefore, they report their revenues, earnings and dividends in their local currencies, rather than in US dollars. As a result, it makes sense to focus on the trends in dividends in the local currency, not in the US dollar equivalent of those dividends. This is because the values of most foreign currencies fluctuates against the dollar, it is quite possible that even a rising stream of dividends denominated in a foreign currency could end up fluctuating up or down in dollar terms from year to year.

The misconception I see every single time I interact with dividend investors is that they always focus on the dividends paid in US dollars from those foreign based corporations, rather than the dividend payment trends in the local currency. As a result of the reasons mentioned in the preceding paragraph, the dividend investor might see that the dividend payment has decreased in US dollars due to currency swings, and make the wrong conclusion that the dividend streak is either broken or non-existent in the first place. This could lead them to sell a security, despite the fact that the dividend payment has increased in the reporting currency.

Because the companies report in local currencies, their board of directors can authorize dividend increases in local currency only. Therefore, investors should focus only on the items that are within the control of management, and dividend hikes in local currencies are one such item. Making sure that dividends from UK based, Swiss based or Canada based corporations maintain a steep rising trend in US dollars is outside the competency of those management teams. However, if Nestle decides to raise dividends for a 19th year in a row in Swiss francs, which sends a strong signal for me that management has optimistic expectations about the business. I don’t care subsequently whether the US equivalent of the increased dividend amount per share in Swiss francs is lower this year versus the dollar amount of last year’s dividend, because currency rates swing unexpectedly in both directions. In the past 20 years that I have paid attention to the currency exchange rates for the currencies of major developed countries, I have found out that these fluctuations are mostly a wash anyways.

Full Disclosure: Long DEO, UL, NSRGY

Relevant Articles:

Four International Dividend Stocks to Consider
Unilever (UL) Dividend Stock Analysis 2015
Diageo (DEO) Dividend Stock Analysis
International Dividend Stocks – Pros and Cons
International Dividend Achievers for diversification

28 comments:

  1. Incidentally I was yesterday doing this exercise with GSK, it looks like they've increased the dividend in GBP for last 10 years, but its almost frozen now. Another source of problems when checking it in the local currency is also taking into account the ADR to local shares ratio.

    ReplyDelete
    Replies
    1. That is a good point that you have to be cognizant of the ADR to local share ratio. Plus, some ADR’s also charge you money for holding foreign shares.

      Delete
  2. Great post!

    Being based in Europe, I am myself biased towards European stocks, as I do not have to pay taxes on dividends from European based companies. Do you have any other European dividends growth stocks on the radar?

    Best,

    ReplyDelete
    Replies
    1. I think you should take a look at Ocean Yield. Very interesting company, with a stated goal of being a dividend machine.

      Delete
    2. I think a lot depends on the tax agreements between your country and other countries. For example, US investors who hold shares in British companies do not have any dividend taxes withheld from the source. With Canadian companies however, I get 15% withheld at the source. I can get a tax credit for those amounts however from Uncle Sam.

      You might find those lists helpful: http://www.nomorewaffles.com/euro-dividend-all-stars/
      http://dividendlife.com/index.php/uk-dividend-champions-home/
      http://www.dividendgrowthinvestingandretirement.com/canadian-dividend-all-star-list/

      Delete
  3. Exactly. This is the only issue I have with the "Champions" list. Thank you for spelling this out so clearly.

    ReplyDelete
    Replies
    1. The dividend champions is a very good list for US stocks. But for international stocks my guess is that one needs to look at the international lists not US based ones

      Delete
  4. How many stocks you are long? It looks like u have more than 30-40...etc. It is amazing that you track all. i am finding difficulty in time,

    ReplyDelete
    Replies
    1. You might like this article: http://www.dividendgrowthinvestor.com/2015/09/how-i-manage-to-monitor-so-many.html

      Thanks for reading

      Delete
  5. I was thinking of investing in DEO as my next purchase. Is the tax reporting different than other dividend stocks in the US? Thanks.

    ReplyDelete
    Replies
    1. Dividends on British stocks are not subject to a withholding tax for US investors. Receiving a dividends from DEO is similar to receiving a dividend from KO ( though DEO pays twice/year)

      Delete
  6. I wish there was a better resource like the CCC list for international companies and dividend growth streaks. I hope to add both DEO and NSRGY to my portfolio at some point. Great companies that should continue to deliver dividend increases for years. The foreign tax issues is probably something else that turns investors off from investing. It's just so much simpler to deal with US based companies only but that call allow those that are willing to do the work to get better values on their capital.

    ReplyDelete
    Replies
    1. Hi PIP.

      There are some good resources on international dividend growth stocks I listed in my reply to the European investor above.
      You can also check the list of international dividend achievers: https://www.invesco.com/portal/site/us/investors/etfs/holdings/?ticker=PID

      I agree that investing in foreign dividend stocks is a little bit more complicated due to withholding taxes, fees, etc. Some US brokers are not very good at handling foreign tax withholdings.

      I have found that focusing largely on US stocks, I get the international exposure through their foreign operations. And I do not have to deal with withholding taxes. However I do agree that by casting a wider net, you get a better chance to find a better value for your investment dollars.

      Delete
  7. DGI,

    I agree with your statement that it could cause some to sell. Being long CM and UL, I have seen how dividend payouts can fluctuate due to relative strength of the dollar and foreign currency. For instance, CM raised its dividend this past year, however it was not realized by me due to currency issues. This is no reason to sell, frankly it is just another factor that needs understanding especially since foreign stocks can present excellent opportunities.

    - Gremlin

    ReplyDelete
    Replies
    1. Thanks for stopping by. I agree with you that this is not a reason to sell. I also agree that you can potentially find great ideas by widening your search for investment opportunities abroad.

      The only reason I wrote this article in the first place is because I have seen this issue pop-up a lot on other sites dedicated to dividend investing. An author would say that Nestle or Diageo or a Canadian Bank cut dividends, when in reality they raised them in their local currency. The author was just focusing on the dividend payment in US dollars, which is misleading. ( and if they miss such an obvious thing I wonder if I can trust their judgement with selecting dividend growth stocks)

      The fluctuation is due to changes in the currency rates between the US dollar and the pound or the euro or the Canadian dollar. For most developed countries, the changes in exchange rates are mostly a wash in the long run.

      Delete
  8. @ Passive IncomePursuit... International lists similar to the U.S. CCC List are the "Canadian Dividend All-Star List" and the "UK Dividend Champions". These lists as well as the CCC list are linked here: http://www.dripinvesting.org/Tools/Tools.asp

    ReplyDelete
    Replies
    1. Bernie,

      I agree, that's a very good resource

      Thanks for stopping by!

      Delete
  9. @ Dividend Gremlin... CM and UL are two companies that have never cut their dividends in their home currencies. Unilever currently has a 26 year record of continuous dividend increases. CM's has only 3 years of continuous increases but they are one of three Canadian banks that have never cut since inception over 150 years ago. TD and BNS are the other two.

    ReplyDelete
    Replies
    1. Based on my research of historical data, Unilever has increased dividends every year since 1996:
      http://www.dividendgrowthinvestor.com/2015/02/unilever-ul-dividend-stock-analysis-2015.html
      Looks like the dividend was frozen in 1995.
      The Canadian banks have done really well for investors. If you ever look at the stock tables at old newspapers from the early 20th century, you could see names of the Canadian Banks there ( and Canadian Pacific railroad).
      Do you by any chance have a resource that shows uninterrupted annual dividends on those banks over the past 100+ years? I could only find BNS

      Delete
  10. For DEO, the U.S. has a tax treaty with the U.K. and there are no foreign dividend taxes withheld. The same for UL I believe.

    Thanks DGI for the enlightening post!

    ReplyDelete
  11. Great stuff. Really need to add DEO in our portfolio.

    ReplyDelete
  12. We had a problem with huge withholding taxes of NSRGY in our regular RBC Direct Investing account and after contacting Nestle I got some forms/letters for RBC to reduce the withholding (or claiming it back) but RBC said they didn't do that so we sold Nestle in the end because it just wasn't worth it after the additional withholding taxes. I think it was like 30% or so. There were better opportunities.

    ReplyDelete
    Replies
    1. I am not sure what the tax treaties between Canada and Switzerland say. In the US, if your broker is good, they should withhold 15%. If they are not good, they would tell you to reach out to the Swiss Tax Authorities. This is a telling sign that they do not want my business, and I should move my investing dollars elsewhere ( or invest my new investing dollars elsewhere)

      Delete
  13. For you Americans, if you have foreign withholding on your dividends, you can usually get it back at tax time on form 1116. It isn't very troublesome to fill out. Maybe three minutes of your time. I have always recovered 100% of my foreign withholding on dividends.

    ReplyDelete
  14. One the one hand your broker in the USA will list "foreign tax paid" on your 1099 and you will be able to recoup this as a foreign tax credit (within a certain limit without having to file Form 1116).

    On the other hand, if you hold the shares in a tax deferred account (IRA, Roth IRA, etc) there is no way to get this withholding back.

    ReplyDelete

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