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By Jeremy Glaser | 03-09-2010 05:27 PM

Should You Look Abroad for Dividend Yield?

Morningstar DividendInvestor editor Josh Peters thinks most investors should stay close to home when looking for consistent dividends.

Jeremy Glaser: Should you look abroad for dividend yield? I'm Jeremy Glaser with Morningstar.com. I'm here today with Josh Peters, editor of Morningstar DividendInvestor, to see if it makes sense to go overseas to look for more income.

Josh, thanks so much for joining me today.

Josh Peters: Happy to be here.

Glaser: Have you seen a lot of opportunities in non-U.S. stocks when it comes to dividend yields?

Peters: Well, I'll tell you, there can be. On the surface, there are a lot of markets internationally that have higher current dividend yields than the U.S. market does. 3% or 4% is not uncommon. Here our S&P 500 yields less than 2% a lot of the time.

But that said, there's more than just current yield at work. There's some drawbacks that investors should be aware of before they start looking abroad for income.

Glaser: What are some of the issues that people will face if they're looking outside of the U.S.?

Peters: Well, currency is a natural one. If you buy a company based in Europe it is going to be, in all likelihood, earning a lot of its revenues and profits in euros. It's probably paying its dividends in euros. If the euro falls relative to the U.S. dollar, then your income from that company is going to shrink.

And most U.S. investors have U.S. denominated living costs and other financial obligations to meet, so currency is one consideration.

Another big one is taxes. Many countries around the world will have withholding taxes that are assessed against dividends being paid to foreign investors. Because they're not getting to tax the shareholders in their own country, they'll try to tax the money as it leaves the country.

And then finally another point to consider is that dividend payment practices are not always consistent. Whatever the drawbacks of U.S. dividend policies - and they are many, mostly in the lack of enough cash - you tend to get predictable quarterly payments. You can pretty much, most of the time, assume that whatever the company paid last quarter, you should get this amount this quarter or more.

That's not the case elsewhere in the world where, say in the continent of Europe, annual dividend payments are pretty common. And if earnings drop, the dividend will drop. The companies there will be more likley to, say, hold the dividend payout ration - the proportion of earnings being paid out as dividends -- and hold that constant, rather than try and hold the nominal dividend rate constant.

So that introduces some more variability. You might own a stock for a full year, think you're going to get a 5% yield, and then it turns out to be 3%.

Glaser: A lot of investors look abroad because they want less exposure to the United States economy. They're worried about U.S. consumers, worried about debt levels, and they want that exposure to Asia and to Europe.

Is there any other way, if you think it's maybe not a great idea to buy the international stocks, to get that kind of exposure?

Peters: Yeah. I think buying U.S. multinationals and other U.S. companies that perhaps in some cases have all their operations outside the United States - a Philip Morris International, a great example of that.

They give you the opportunity to have a lot of the advantages to investing domesticlly: predictable dividend paying practices, you don't have withholding taxes, you owe tax on the dividends that you receive perhaps, but you won't have this extra withholding tax that you might just lose as an investor in a qualified account.

You're going to have your traditional American GAAP to prepare your financial statements. Everything is just a lot simpler. You've got all the transparency and built-in advantages of being a domestic investor, but you're still getting a lot of international exposure.

Think about the big healthcare companies like Johnson & Johnson and Abbott Labs: 50% of the business or thereabouts is overseas. As overseas markets are growing throughout the world, you get that growth and you get it translated back into dollars. And if the dollar depreciates that'll benefit you investing in these companies.

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