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

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