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Should You Look Abroad for Dividend Yield?

Jeremy Glaser

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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Glaser: If you're absolutely dead set on buying a dividend-paying stock outside of the U.S., do you have any suggestions right now?

Peters: The way I like to think about is, for me to buy something that is based in a different country, where I'm not on the ground, I'm not watching the same TV shows or reading the same papers, just kind of being part of another society - I feel like I need a higher hurdle rate, a higher indicated return, which I define as dividend yield plus dividend growth prospects, in order to feel like I'm getting enough to compensate me for the additional risk.

And one of these companies that has met this hurdle for me is a utility company called National Grid. It's based in the UK. The UK is already a pretty good country to go prospecting for dividends because there's a consistent set of dividend payment practices.

Most companies pay twice a year. They have what's called a smaller interim dividend, then a larger final one. But usually whatever you get will be at least equal to what you got for that payment a year ago. So you've got some consistency there.

You also have a tax treaty between the UK and the United States, which means you don't have that withholding tax issue you would have with buying, say, Nestle, a Swiss company. Or even Canadian companies, there's a 15% withholding tax you may have to deal with.

But what I really like about the business is that there's sort of a natural hedge built into National Grid. About half of the business is actually here in the United States, where National Grid has acquired transmission and distribution utilities in the Northeast. So I know how those work. Being a U.S. investor and a U.S. utility customer, I've got a pretty good idea how those work.

In the UK what you have is a regulatory framework where prices and revenues and even profits, by extension, are really set on an inflation-indexed regime. So if you think about the currency risk associated with investing a business that half the business is in the UK, if you saw a big depreciation in the pound, chances are you'd also see some inflation pass through.

National Grid would benefit from that. They would essentially get that real return restored to them, and they would be able to pass on that higher dividend rate to their shareholders.

So there's a lot of very good things about National Grid as a business. There are a lot of good things about the UK in general in terms of structure for those who would look for overseas income. But the pound has been falling, Britain's got some pretty severe economic problems. Even there, I think it pays to be picky. But National Grid is one that I do like.

Glaser: Great. Josh, thanks for taking the time today.

Peters: Happy to be here.

Glaser: For Morningstar.com, I'm Jeremy Glaser.