U.S. stock and bond markets gave investors much to like last year. Stocks closed 2019 with a string of records. Treasuries rallied, as investors sought havens from geopolitical storms.
The one thing they didn’t provide? Strong yield.
The S&P 500 index’s (.SPX) dividend yield was recently 1.80%, down from 1.92% as recently as October—and a reminder of how well U.S. stocks have performed during the decadelong bull run. As stock prices go up, yields tend to compress.
The 10-year Treasury, meanwhile, recently yielded 1.6%, versus 1.9% at the end of last year. Its decline has been driven not only by its status as a haven asset, but also thanks to the Federal Reserve’s reversal on monetary policy; the central bank cut short-term interest rates three times last year and says it expects to keep them steady for a while.
Income investors need not despair. While bond yields in many parts of the world are even lower than they are in the U.S., there’s plenty of yield available in a sometimes-overlooked corner of the market: international dividend stocks.
“If you are an income investor, especially with any long-term thought process, it really makes sense to be a global investor, as opposed to being just a domestic one,” says Jason Brady, CEO of Thornburg Investment Management and a portfolio co-manager of the Thornburg Income Builder fund (TIBAX). “You are getting better value in other parts of the world.”
Just consider the recent dividend yields of several international stock indexes compared with the S&P 500’s 1.8%. The DAX (DAX/IV) in Germany was at 2.9%, and the FTSE 100 (.FTSE), which tracks companies in the United Kingdom, yielded 4.6%. The Topix (.TOPX) in Japan, where yields have been on the rise as companies allocate more capital to dividends and buybacks, was at 2.3%. The Ibovespa in Brazil was offering 2.9%.
Another selling point for overseas dividend stocks is that, along with higher yields, many sport lower valuations than U.S. shares. The S&P 500 recently fetched 18.7 times the current fiscal year’s profit estimate, compared with 14.6 times for the Topix, 13.6 times for the FTSE 100, and 13.8 times for the Ibovespa.
So why have U.S. investors, by and large, stayed away from overseas dividend payers?
“There has always been this home-country bias,” says Jeremy Schwartz, global head of research at WisdomTree. “The U.S. has been outperforming everywhere else. Diversification hasn’t worked because the U.S. has been the only place to be.”
A recent Vanguard Group study of customers in its Personal Advisor Services found significant home bias: 83% of those investors allocated 10% or less of their portfolio to international investments.
What’s more, U.S. investors are sometimes vexed because many dividends paid by international companies are subject to a withholding tax. It’s more of a burden for investors in tax-advantaged accounts such as 401(k)s or IRAs.
Another difference: International dividends aren’t typically paid every quarter, as they are in the U.S. Policies vary, and some companies disburse a dividend once a year; others, twice. In addition, the amount of the payouts can vary significantly from one period to the next.
Still, certain international stocks offer plenty of fundamental appeal and diversification, especially at a time when many bonds continue to have low yields and traditional dividend-paying U.S. stock sectors, such as utilities and real estate, have been bid up.
“There is a much broader menu of high-dividend stocks to select from when you look outside our borders,” says Jared Hoff, a portfolio manager of the Federated International Strategic Value Dividend fund (IVFAX).
Of the 615 U.S. companies in the MSCI World Index (.MIWO00000PUS), only about 20% have yields above 3%, according to J O Hambro Capital Management. But more than 40% of the 1,031 non-U.S. companies in the index sport yields above 3%.
There is no free lunch, of course, and international equity markets do pose risks. Many of their home countries’ economies aren’t that robust, for starters. Goldman Sachs (GS) expects that, in 2020, real gross domestic product will grow 1.1% in continental Europe and the U.K. and 0.4% in Japan. Overall, the firm sees 1.7% growth in developed markets this year, compared with 4.8% in emerging markets, helped by a big lift from China, where it expects an increase of 5.9%, despite the coronavirus’s potential effects on the economy there. It forecasts 2.2% GDP expansion for the U.S.
By investing in international stocks, U.S. investors also face currency risk when they buy or sell an overseas stock. If the dollar is weak, it buys less of the foreign currency. Conversely, when the dollar is strong, as has been the case in recent years, it purchases more.
Another consideration: A lot of the higher-yielding stocks overseas fall into the value camp, just as they do in the U.S. Value shares have lagged behind growth names for much of the past decade. Says Schwartz: “A lot of international markets are more value-oriented.” But “if valuation starts to matter, we might see a return to some international stocks.”
Despite sluggish economic forecasts, especially in developed markets, and uncertain currency impact, the foundation for dividend growth in international markets looks sound. True, there have been a few notable dividend cuts— Deutsche Bank (DB), for example, said last year that it was suspending its common stock dividend for two years as part of a restructuring—but they are not widespread.
“Right now, we’re in a low-growth environment, but companies that can expand at about the rate of GDP are still able to maintain their dividends or bump them up modestly,” Hoff says.
A big reason for the yield disparities between U.S. and overseas markets is stock buybacks.
They are popular in the U.S., but much less so elsewhere. In 2018, the 1,000 largest U.S. companies by market capitalization repurchased $703.2 billion worth of stock on a net basis, according to the Leuthold Group. That’s significantly more than the $131.5 billion in repurchases that year by international companies in the MSCI EAFE Index (.MXEA), which excludes the U.S. and Canada.
Driving the regional yield disparity in large part are differences in corporate cultures and investor expectations. Many U.S. managers favor the flexibility of a buyback, which can be trimmed or even halted with less pain than a dividend cut or suspension.
As for investors, “Outside the U.S., shareholders have long required a cash return on their investment—more so than here in the U.S.,” Hoff says.
There are other reasons for this preference for buybacks over dividends at U.S. companies.
For one thing, many U.S. executives’ pay is tied to stock performance or partially disbursed in shares, and buybacks, which reduce share count, tend to boost stock prices. “These [compensation practices] provide a strong incentive to favor buybacks that support stock prices over dividends,” says Giorgio Caputo, head of multi-asset strategies at J O Hambro.
There’s also the issue that dividends, unlike buybacks, are subject to near-term taxation, while share repurchases can generate capital gains that come due only after an investor sells a holding. Some managements prefer to avoid the tax on dividends, and so opt for buybacks instead.
Overseas dividend payers also bring sector breadth that is largely lacking in the U.S. Technology stocks, for instance, are a dominant force in American markets, but many don’t pay dividends because they prefer to retain their cash to fund their growth.
In contrast, says Hoff of Federated, “many international markets are more heavily weighted in sectors outside of technology, where growth rates and capital requirements are lower.”
While many U.S. dividend-paying stocks are confined to sectors such as utilities, real-estate investment trusts, and consumer staples, there are broader opportunities internationally. “It’s just not as skewed to those bond proxies like it is in the U.S.,” Caputo says.
Ultimately, investing in dividend stocks outside the U.S. is similar to selecting investments at home when it comes to the basic objective. “It’s about finding companies that have the growth and cash flow that can support a growing dividend over time,” says John Tobin, a portfolio manager at Epoch Investment Partners. And in many cases, investors can even buy the U.S.-listed American depositary receipts of large foreign companies instead of the locally listed shares.
For some yield-generating ideas, Barron’s spoke to a number of portfolio managers. Here are some of their picks:
Europe / U.K.
While the economic outlook in continental Europe and the U.K. isn’t exactly robust, and the region continues to deal with the fallout from Brexit, there are plenty of companies that offer good yields and solid prospects—and improving capital-allocation priorities.
“European and, to some extent, Japanese companies have become more shareholder-oriented over the past 20 years. It used to be that a lot of companies in Europe and Japan didn’t care about it,” says Thomas Shrager, a managing director at asset manager Tweedy, Browne. “In a sense, the world has become more homogenized in the way it looks at capital allocation.”
One subset of regional dividend payers to consider is made up of continental European and British companies that do a lot of business outside of the country in which they are headquartered. “It’s actually much more important to look beyond domicile and look where the companies do business,” says Caputo.
One such holding of J O Hambro is Compass Group (CMPGY), a U.K.-based food-service and catering company. The stock yields 2%. Compass generates more than half of its revenue in the U.S.
The company pays a dividend twice a year, as do many continental European and British companies. In November, it declared a payout of about 27 British pence, around 35 cents. That was preceded by a so-called interim dividend earlier in the year of about 13 pence. Both payments were roughly 6% higher than those a year earlier.
As of Sept. 30, the company’s operating cash flow over the previous year totaled about $1.7 billion, well exceeding the $800 million in dividends it dispensed.
Another European company with large operations abroad is Swiss pharmaceutical maker Novartis (NVS). The stock yields about 3%. Its top-selling drugs include Tasigna for cancer, Cosentyx for immunology, and Gilenya for multiple sclerosis. The company just past week proposed a dividend of 2.95 Swiss francs a share, or $3.05, up 4% from the level the previous year and in line with prior dividend increases. “It has a very, very reliable dividend, and the dividend yield is attractive,” Tobin says. “They use excess cash flow to buy back stock, as well.”
Last year, the drug producer’s free cash flow was $12.9 billion, of which $6.6 billion went to dividends and $5.4 billion to share repurchases.
The largest holding in the Thornburg Investment Income Builder fund (TIBAX) is Orange (ORAN), a telecommunications firm based in Paris. The stock yields 5.4% and trades at a little more than 13 times this year’s consensus profit estimate, according to FactSet.
“We don’t love the sector, but Orange is executing very well, and the price is pretty cheap,” Thornburg’s Brady says.
The ADR has a total return of minus 4% over the past 12 months.
The telecom pays an interim dividend and a final dividend, standard operating procedure for many European companies. Last October, it declared a final dividend of 40 euro cents—unchanged from a year earlier—or about 44 U.S. cents. The interim dividend of 30 euro cents also remained the same.
For investors loath to pick individual stocks or even regions, one option is the Vanguard International High Dividend Yield Index exchange-traded fund (VYMI). It was recently yielding 4.12%, according to Morningstar. The fund, which weights its holdings by market capitalization, is heavily tilted to developed markets.
Due to its weighting methodology, the fund has a “pretty diversified portfolio, emphasizing bigger companies,” says Daniel Sotiroff, an analyst at Morningstar. It also has a value bent.
The fund’s expense ratio is 0.32%. As of Jan. 27, it had a three-year annual return of 5.62%, placing it in the top third of its Morningstar category.
Emerging Markets / China
Dividend plays tend to be more common in developed markets, such as continental Europe, the U.K., and Japan, as evidenced by the weightings of various mutual funds that search international stock markets for income.
Many emerging market companies are still in their earlier development stages, meaning they tend to reinvest their cash flow to fund growth. “Dividends are not necessarily top of mind when you are evaluating those businesses,” says Conor Muldoon, a portfolio manager at Causeway Capital Management.
Still, investors shouldn’t overlook emerging markets, particularly China, with its strong long-term economic prospects.
“China is a place where you are going to have growth,” says Carl Weinberg, founder and chief economist of High Frequency Economics, a consulting firm. “So if economics is one of the drivers you are looking for, you are going to get more of that out of China than anyplace else.”
While the coronavirus outbreak remains a wild card, he expects China’s GDP to grow by at least 6%—right about where Goldman Sachs forecasts it for 2020—”even in a bad year.”
Joyce Li, a co-manager of the Matthews China Dividend fund (MCDFX), says there’s no shortage of dividend payers in that market. As of Dec. 31, the fund’s trailing dividend yield was about 3.5%.
In terms of returning capital to shareholders, says Li, “in most cases, the dividend is the preferred way” for Chinese companies as opposed to stock repurchases.
Sector weightings in the MSCI China Index (.MSCICN) include real estate at 6%, consumer discretionary at 27%, consumer staples at about 4%, and industrials at 6%. “There’s a diverse cross-section of companies paying a dividend,” says Li.
The fund recently initiated a position in Gree Electric Appliances of Zhuhai (000651.China), which Matthews describes in its most recent quarterly commentary as the largest air-conditioner maker in China. The local government sold its stake in the company last year to a private-equity firm, according to Matthews, and the stock yields about 4%.
“We truly believe in the middle-class spending story in China,” Li says, adding that the company possesses strong brand recognition.
Matthews says in its commentary, “We believe that the company, with a better management incentive plan, will be able to deliver stronger growth and that the new owner also is committed to a relatively high payout ratio.”
Another company some portfolio managers like is China Mobile (CHL), whose American depository receipts recently yielded 4.3%.
Muldoon, whose company holds Hong Kong–listed shares of China Mobile, asserts that the company is poised to see higher revenue per user as it transitions to 5G services.
China Mobile, he says, has a strong balance sheet “that really supports their ability to invest in that new network to grow the business, and at the same time they pay shareholders a dividend.”
Muldoon also likes SK Telecom (SKM), a large wireless operator based in Seoul. The stock yields about 4%. Helped by strong cash flow, the company pays out about 60% of its earnings in dividends, he says.
“That gives us confidence that they can continue to grow and pay out this dividend over time.”
Asia / Japan
Japan hasn’t historically been known as a dividend haven for equity investors, with companies tending to hoard cash or use it for other purposes. That’s changing.
Corporate-governance initiatives under Prime Minister Shinzo Abe, who took office in 2012, have helped. One effort, called the corporate governance code, says in part that boards should enhance “capital efficiency”—code for how corporate capital is allocated. Another measure, the Ito Review, “has contributed to a change in management behavior, and the structural improvement in capital efficiency,” according to a 2018 research note by Lazard Asset Management.
Buybacks set a record last year at 6.7 trillion yen, according to Morgan Stanley. That’s about $60 billion, based on recent exchange rates.
“It’s all about encouraging Japanese companies to be better capital allocators—to pay dividends with excess cash flow and not to hoard cash,” says Tobin of Epoch Investment Partners.
A Japanese stock that Epoch owns is Tokio Marine Holdings (TKOMY), whose operations include life and property-and-casualty insurance. Over the past three years, the holding company’s dividend has grown at an annual clip of 14%. “Their goal is to grow the dividend with earnings,” Tobin says.
The stock yields 3.2%, and the company also paid out special dividends in 2018 and 2019 of JPY70 and JPY35 a share, respectively. Tokio Marine has said that it wants its payout ratio, which measures the percentage of earnings paid to shareholders via dividends, to increase gradually. It recently was 38%.
Causeway’s Muldoon cites Takeda Pharmaceutical (TAK) as another solid dividend play. It yields about 4.2%. Takeda is the largest pharmaceutical company by sales in Japan.
Takeda boosted its size with its acquisition last year of Shire, a biotech firm based in Ireland whose specialties include immunology and genetic-disease treatments. While the $60 billion deal helped Takeda expand its footprint in the U.S. and made it less reliant on Japan, it did increase Takeda’s debt load.
In recent years, the company has been paying out JPY180 per share in dividends annually. Muldoon, who describes Takeda as a “very defensive” and “pretty diversified pharmaceutical business,” maintains that the cash flow of the combined company will help pay down debt, fund capital expenditures, and help increase the dividend over time.
Investors have been cautious on Takeda stock, which is down slightly, dividends included, over the past year.
Another dividend payer to consider: Taiwan Semiconductor Manufacturing (TSM). It’s not a pure play on developed markets, though it certainly leans that way. In 2018, the chip maker generated about two-thirds of its revenue in the U.S. and Japan.
“It’s pretty developed in its market exposure,” Brady says.
Finding income stocks with nice yields in the tech sector isn’t always that easy, and Taiwan Semiconductor offers about 3%.
Abhinav Davuluri, an analyst at Morningstar, noted recently that “the company has done a good job of returning excess cash to shareholders, paying a healthy annual dividend.”
It’s in a cyclical business, but Davuluri adds that the chip maker has been showing more discipline in its capital expenditures and expansion plans in recent years.
Dividend yields are plentiful in many international markets, from France to China—requiring investors to have some knowledge of those locales. Understanding just how solid those payouts are, however, is a universal challenge.
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