Looking Abroad for Dividend Growth
Dividends overseas may entice income-seekers, but mind the risk and taxation challenges.
Investing in U.S. equities with consistent dividend growth isn't what it used to be.
U.S. dividend investors, once confident in the dividend growth of their stocks, are becoming skeptical. Why?
U.S. payouts during the second quarter of this year experienced the slowest rate of growth since 2013, due to subdued profit gain and a strong dollar that pressured profits earned abroad by U.S. companies, according to a study by Henderson Global Investors. In fact, the dividend-growth slowdown in the U.S. started late last year as several sectors, including energy and mining, continued to suffer from the sharp fall in commodity prices.
Investors seeking continued dividend growth might look abroad to developed and emerging-markets that offer steady dividends yields.
"It's worth investing overseas to capture dividend growth," says Andrew Foster, chief investment officer and lead manager of the now closed Seafarer Overseas Growth and Income (SIGIX), which earns a Morningstar Analyst Rating of Bronze.
Here are three things investors who are looking abroad for dividend growth should consider.
Although dividend-paying companies across the globe are generally more solvent and less volatile than non-dividend paying stocks, seeking dividend growth abroad comes with risk.
The most notable for U.S. investors: currency risk. The U.S. dollar has been remarkably strong of late, cutting into the returns of U.S.-based investors who own unhedged exposure to international markets. Many emerging-market currencies have experienced sharp swings, thanks to plummeting commodities prices and economic slowdown.
In general, currency movements of developed markets such as those in the eurozone or Japan tend to be less pronounced compared to currencies of emerging countries such as Russia, Brazil, or Turkey.
Taxation is another complication faced when investing in international dividend-paying stocks. Those investing in foreign dividend-paying stocks in their taxable accounts should be aware of two issues detailed in this article.
The first issue is withholding taxes on dividend income. There are many countries that impose tax withholding at the source on dividend or dividend paid to foreigners. Here is a list of countries by the level of dividend withholding tax they impose.
The U.S. government, in order to prevent double taxation, allows investors to claim the withholding amount as a tax credit, explains Patricia Oey, a senior fund analyst at Morningstar.
"At the end of the year, fund companies provide investors with tax documents, which list the amount of foreign taxes paid per share," she says. "Investors can aggregate the amount of foreign taxes paid across their international funds, and claim it as a tax credit." Claiming a tax credit only works for investments held in taxable accounts.
Another issue involves U.S. taxes and qualified dividends.
"Foreign dividends are considered qualified (for the 15% rate) if they are paid by a company domiciled in a country that has a tax treaty with the U.S. and if the fund has met the holding-period requirement for the stock," says Oey. Dividends paid by companies from countries that do not have tax treaties with the U.S. are subject to regular income-tax rates.
"Investors can find out which of their dividends are qualified by checking the tax documents issued by the fund providers at the end of the year," notes Oey.
Due to these tax considerations, it is important for investors to think about net dividends and not just gross dividends.
Dividend Distribution Rates and Schedules
Dividend distribution is another issue to be aware when investing abroad. Historically, dividend payouts have tended to fluctuate more for international companies compared to U.S. firms, according to Matthew Diamond, manager research analyst of passive strategies at Morningstar.
"This can lead to increased turnover and transaction costs for international dividend ETFs, because many require their stock holdings to maintain or increase dividends year-over-year," Diamond says.
Additionally, U.S. companies lean toward paying quarterly dividends, whereas many international companies pay out dividends semiannually. That's a big reason why during the second quarter this year Europe saw a dividend payout increase of 4.1% compared to an increase of just 1.2% in the quarter worldwide.
For investors interested in dividend-paying companies overseas, there are a few stocks in Morningstar's coverage area as of this writing. All of these stocks appear on Morningstar DividendInvestor's Income Bellwether's list, which is a list of stocks that are widely held by income investors. Further, these stocks are trading in 4- or 5-star range, which means they are selling below Morningstar's estimates of their intrinsic worth; they carry wide moats, meaning they have unassailable competitive advantages; and they yield 3% or more as of this writing.
Nestle (NSRGY), the world's largest food and beverage manufacturer by sales, offers a 3.16% dividend yield as of this writing and has experienced 11% average annual dividend growth over the past five years.
"Nestle's historical rate of growth will be more difficult to achieve going forward," notes Morningstar strategist Philip Gorham in his latest analyst report. "Nevertheless, the firm's wide moat should defend Nestle from the evolving threats of new entrants through the online channel and growth of low-priced substitute products."
Novartis (NVS), the Swiss-based developer and manufacturer of healthcare products and pharmaceuticals is well-positioned for steady long-term growth, says Morningstar's sector director Damien Conover in his latest report: "Strong intellectual property supporting multibillion dollar products, combined with an abundance of late-pipeline products, creates a wide economic moat. While the recent patent loss on Diovan and the 2016 patent loss on Gleevec will weigh on growth, the company's strong strategic position should lead to solid long-term growth." With a current 3.6% yield, the stock has generated 6.5% average annual dividend growth over the past five years.
Roche Holding (RHHBY) is a pharmaceutical and diagnostic company that researches and produces medicines in oncology, infectious diseases, immunology, and neuroscience. The Swiss firm offers a 3.55% yield and 5.1% average annual dividend growth over the past five years. In her latest analysis, sector strategist Karen Andersen notes that Roche "has a strong portfolio, pipeline, and diversification as the global leader in diagnostics; as such, Roche's wide moat remains strong ahead of competition."
French healthcare company Sanofi (SNY) is projected to have a "five-year average annual revenue growth rate of 2%, largely driven by steady gains with consumer products and vaccines along with new product launches offsetting deteriorating pricing for the company's top drug Lantus," notes Conover in his latest report. "Following a sharp patent cliff in 2013, Sanofi faces relatively mild patent losses, and diverse operations in vaccines, consumer products, and emerging-markets should lead to steady growth over the long term." The stock currently yields 4.4% and has experienced 10.0% average annual dividend growth over the past five years.
Funds and ETFs
Investors can get exposure to foreign dividend-paying stocks through funds. Here are a few of Morningstar's favorites that are open to new investors.
Silver medalist AllianzGI NFJ International Value (ANJIX) has a mandate that all holdings must pay a dividend and that each of them trades at an attractive valuation relative to its peers.
"The portfolio's often sizable stake in emerging-markets, which currently takes about 20% of assets, also distinguishes the fund from its typical peer, which holds just 5% of assets in developing countries," says analyst Leo Acheson in his analyst report.
American Funds International Growth and Income (IGAAX) earns a Morningstar Analyst Rating of Gold "because it remains a great long-term option," says analyst Alec Lucas in his fund report. "The fund strives for a yield within the range of its index, which is currently about 3.6%. That's significantly lower than the MSCI EAFE High Dividend Yield Index's 5.4% and does not force the managers to stretch for yield."
Unlike others mentioned here, Silver medalist Tweedy, Browne Worldwide High Dividend Yield (TBHDX) invests in U.S. dividend payers in addition to foreign fare. The fund is "usually at its best during bear markets," notes Kevin McDevitt in his analyst report, even though it trailed the MSCI World High Dividend Yield Index during the 2015-16 bear market. Says McDevitt: "The fund's consistent underweighting of U.S. equities has been a significant handicap. While its benchmark has a 51% U.S. weighting, the fund rarely goes above 22%, in part because higher yields are found overseas."
Among passive investments, iShares International Select Dividend (IDV) is one of the highest yielding international equity funds with a current yield of 5%.
"Its diversified, reasonably priced portfolio holds 100 high-dividend-yielding companies listed in developed countries in Europe, Australia, Asia, and Canada that have passed a series of dividend sustainability screens," says analyst Matthew Diamond in his latest report. "However, the fund can, at times, take concentrated bets, which can create significant risk in the portfolio." The fund earns a Neutral rating from Morningstar.
Manuela Badawy is a freelance columnist for Morningstar.com. The views expressed in this article do not necessarily reflect the views of Morningstar.com.
Manuela Badawy does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.