Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. Many investors looking for higher yields have been going abroad. I'm here with Josh Peters--he's editor of Morningstar DividendInvestor newsletter and also director of equity-income strategy--to see what some of the pros and cons are of investing abroad. Josh, thanks for joining me today.
Josh Peters: Good to be here, Jeremy.
Glaser: Why are investors looking overseas for more yield? Generally speaking, do European or Asian companies pay higher dividend yields than their U.S. counterparts?
Peters: Well, there are two components to it that give you higher dividend yields [overseas]. First is that payout policies are more geared toward dividends in other countries while here in the United States, companies in the S&P 500 have actually spent more on share repurchases than on dividends lately. So, that's one piece of the puzzle. Another is that valuations are lower. So, for the same payout ratio, a stock or a country's whole stock market that trades at a lower P/E is going to give you a higher dividend yield. For those reasons, yes--if you are using as your benchmark the S&P 500, yielding about 2%, which is pretty much the yield we've been stuck with here over the last couple of years (on average, more like the last 15 years). Yes, you can get some higher dividend yields in other countries, but there are some trade-offs associated with that.
Glaser: Let's look at some of those trade-offs. What are some of the concerns about doing this? Why wouldn't you move your entire dividend portfolio into higher-yielding geographies?
Peters: I think a big, practical reason is that most people who are looking for a lot of income are typically in portfolio-withdrawal mode. Perhaps they are retired or they have other financial obligations to meet. If they live in the United States--if they are domestic investors--then there is an advantage to having your dividends paid in dollars so that you can meet those dollar-based liabilities and expenditures that you have to meet.
Now, this isn't something that people have talked about a whole lot up until the last couple of months, and then all of a sudden, I start getting emails from DividendInvestor subscribers wanting to know why Unilever (UL) cut its dividend. Well, Unilever didn't cut its dividend. In fact, it paid the same EUR 0.285 for the first quarter of 2015 as it did in the previous quarter and the quarter before that. What's changed is that the euro has dropped from $1.35 to maybe around $1.15 or $1.10. And with that, the dollar income that a U.S. shareholder receives from Unilever has gone down by the identical percentage. So, it's meant a loss of income even though the company itself, in its home currency, is doing fine and continuing to maintain that dividend. So, that's one constraint.Read Full Transcript
Another is that, depending on where you go, you might have to deal with withholding taxes levied by the company's home country against dividends paid to foreign shareholders. Sometimes, you can recover these up to what you would owe as a U.S. shareholder on the dividend through the foreign tax credit. You can't do that in an IRA or other qualified account setting. It's just a dead-weight loss. So, there is another practical constraint. But I think you have to keep in mind that you don't necessarily need to go overseas. You're not just choosing between countries. You are also choosing between areas of the market--and especially sectors of the market--in each geography that you look at.
So, one of the things that really weighs down the dividend yield of the S&P 500, our benchmark index, is the fact that tech companies--even though most of them pay dividends now and they've been raising them--is still a very low-yield sector. Our financial-services sector, in the wake of the crash of 2008-09 with all the dividend-cutting that went on, is also very low yielding. Consumer discretionary is very low yielding. Even our energy companies tend to yield less than their foreign counterparts.
Other than that--and that's a big swath of the market, certainly, that we've talked about here in the U.S. But if you look in other countries, they will be dominated with financials and utilities and staples firms that pay big dividends there, just like ordinarily they would pay big dividends here. Financials are kind of the outlier, as well as materials companies being bigger components of a lot of foreign markets. So, when you look at the cross-section of who is paying and who isn't, there is actually, I think, just as much opportunity to find attractive payout policies among U.S. companies while still retaining all of those practical advantages of getting dollar income and you don't have to go to other countries, necessarily, to find higher yields.
Glaser: Given some of those drawbacks that you just mentioned, are there times that you do look abroad for yield? Should you write off non-U.S. dividend payers?
Peters: I do think it's important to include foreign stocks as part of your opportunity set as a dividend investor. But I don't think it's a good idea to think, "I need a higher yield; therefore, I have to look outside the United States." Instead, I think in terms of applying at least the same standards to any foreign company that I would apply to a domestic one. I'll use one example from my own portfolios: National Grid (NGG). It's a big utility in the United Kingdom. They also own some utilities in the northeastern United States.
I tend to think of [regulated utilities] as being pretty attractive businesses for income investors. National Grid is, frankly, even more attractive in the U.K. because it's indexed directly to inflation, which is a critical difference between itself and most domestic U.S. utilities that, frankly, can be hurt in periods of rising inflation because customer bills aren't allowed to rise as fast, perhaps, as both the capital and operating cost of supplying electricity or natural gas.
Lately, with the decline in the pound relative to the dollar (like most currencies, the pound is falling relative to the dollar), I have lost some of my dollar-denominated income. But the virtues associated with this specific company make up for that. Now, if I were to go even farther afield, and you may not think of, say, Switzerland as going that much farther afield, but if I look at a Nestle (NSRGY) or a Novartis (NVS), they're world-class companies, but in these cases, I've got a Swiss withholding tax to deal with. With IRA money, that could really be a drag not just on my income but on my total return.
So, if I'm going to buy those stocks, I need to get them at pretty big discounts, frankly, to make up for the income I'm losing just to the withholding tax. So, there are some examples of how I think you want to frame the question. In the event that you are thinking in asset-class terms--[say, for instance, you] want more foreign exposure--you can get more foreign economic exposure with lots of big-cap domestic multinationals.
Philip Morris International (PM) operates entirely outside the United States. Coca-Cola (KO) operates in almost every country, I think, except Cuba and North Korea. I think I saw that cited recently that those are the only countries where you can't buy a Coke. I like to get exposure to emerging markets, especially for those staples companies that might have some better long-term growth potential. But I also have to think about the risks I'm taking, and a big multinational like a Coke or a P&G (PG) is going to insulate me from some of those risks as a U.S. shareholder looking for income.
Glaser: Josh, thanks for your thoughts on investing abroad for dividends today.
Peters: Thank you, too, Jeremy.
Glaser: For Morningstar, I'm Jeremy Glaser. Thanks for watching.
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