Financial advisors in search of attractive dividend yields and portfolio diversification for income-hungry clients may want to look abroad at the rising number of international companies offering sustainable and growing dividends.

The universe of foreign companies paying dividends has grown substantially in the past few years. As some U.S. companies have been forced to slash payouts due to the financial crisis, foreign corporations with healthier finances have been increasing dividends. This could prove even more relevant, particularly if the global markets start trading sideways and demand for dividend-paying investments increases, market observers say.

"With overseas markets consolidating 2009's sharp gains, we think it's a good time to revisit the benefits of long-term dividend compounding," Alec Young, Standard & Poor's international equity strategist, said in a recent report. "While big rallies grab headlines, equity markets spend a lot of time trading sideways, highlighting the importance of being paid to wait. Understandably, investors closely track overseas equity price movements, but our analysis indicates they should be just as focused on dividend growth and sustainability, in addition to making sure they are regularly reinvesting the proceeds."

Toward the end of this year's first quarter, international equities on average yielded 2.5% versus 1.9% for the S&P 500 index, according to S&P. Money managers cite attractive dividend returns of 3% to 4%--or higher abroad--as potentially alluring to income-seeking investors, especially those near retirement or in retirement who face domestic yields close to zero on many government securities and money market funds.

But of course, there are a few caveats with international securities such as currency, political and payment risks.

And yield should be only one factor in your investing decision, says Diane Pearson, an advisor at Legend Financial Advisors Inc. in Pittsburgh. "We've gotten involved in more and more country sectors. Yield isn't necessarily the focus in all cases. We use a bottoms up strategy," she says. "What we're looking at first is the manager of the fund, the history of the fund, and the theme of the fund, not just the yield itself."  

Where The Pros Go    
At the country level, many money managers are avoiding struggling eurozone countries such as Portugal, Ireland, Spain, and Italy amid fears the Greek debt crisis could spread. But they continue to invest in such countries as Germany and France, which remain in better shape. Others are buying securities in places like Scandinavia and Switzerland, whose currencies aren't tied to the euro. Asia is also a dividend favorite.

Lisa Myers, who manages the equity portion of the Templeton Income fund, says she's finding attractive values in Europe and Asia--along with the U.S. Within the portfolio's European exposure, Myers likes the healthcare, technology and telecom sectors. One of her top picks, Roche, the Swiss pharmaceutical company that recently purchased Genentech, has a good drug pipeline and had a solid 3.4% dividend yield. Other high-yielding drugmakers in her portfolio include Sanofi Aventis (4.2%) and Merck (4%).

Technology companies in Europe, Asia, and the U.S. also have abundant cash flow streams now being devoted to dividends. "Whether it is Microsoft or Compal Electronics or Taiwan Semiconductor, technology stocks have more net cash on their balance sheets than any other sector, despite what has been a period of weak tech spending by companies," Myers says.

Among this grouping, Taiwan Semiconductor's stock recently yielded 5%, while Compal and Microsoft yielded 3.5% and 1.8%, respectively. "We've been convinced that productivity enhancing tech spending would pick up as companies ran out of cost cutting opportunities coming out of the financial crisis, and we have seen this beginning to occur," Myers says. "So while tech stocks have been performing quite well, current free cash flow yields are still at historically high levels, making these stocks look very cheap."

Ray Mills, manager at both the T. Rowe Price Overseas Stock and the International Growth and Income funds, says dividend yield is just one element among many he uses to evaluate companies. "Within the dividend, we want to find sustainability, the ability to pay and growth."

Mills likes the telecom sector, including such stocks as Spain's Telefonica and France Telecom that were yielding in the 7% to 8% range. He also likes the sustainable dividends found at large integrated oil companies such as Royal Dutch Shell PLC, which recently yielded 6%, and BP PLC, at just under 6%.

"They're not going away tomorrow," says Mills. "It's likely they'll be able to keep paying that dividend or even higher over time, and that's pretty attractive relative to what you can find in the fixed income markets right now."

Asian Opportunities
The situation is somewhat different in Asia. Jesper Madsen, portfolio manager of the Matthews Asia Dividend fund, frequently finds himself debunking the notion that Asian companies are growth companies and therefore are not likely to pay high dividends.

He maintains that growth in dividends in Asia historically has been higher than in the U.S., and cites an internal study covering the period from 2002 through 2008 that shows 18% annualized dividend growth for companies in the MSCI Asia-Pacific Index, versus 10% dividend growth for companies in the S&P 500 index during that period.

"People don't get penalized when they invest in a faster-growth region like Asia-Pacific," says Madsen. "They actually receive a higher dividend yield than in the U.S."

He notes that roughly 5,000 companies in the region with a market cap of $100 million or above, pay dividends. China remains fertile ground for dividend seeking investors. Madsen says the total amount of dividends paid by listed Chinese companies has zoomed from $8 billion in 1998 to $73 billion in 2008. The MSCI China Index recently yielded about 2.8%.

Yet some investors fear a growing bubble in Asia's developing countries. "It depends on what sector you're looking at," says Madsen. "Certain sectors such as consumer-related companies have done quite well. Whether there's a bubble is maybe too strong to say, but valuations are certainly more demanding than they have been in a long time. That doesn't mean, however, you can't find companies that are reasonable within that space."

Risk-Adjusted
David Ruff, a portfolio manager at Forward Management in San Francisco, invests in select dividend-paying companies through his International Dividend Portfolio, a separately managed account that's marketed through the advisor channel. He uses a bottoms-up strategy for screening attractive stocks regardless of their location, but applies a risk-control process to avoid too much concentration in any one country or region.

Generally, Ruff avoids countries with balance of trade problems or extreme political, fiscal, and currency risks such as Greece, Ukraine, and Vietnam. The portfolio has a "healthy" weighting in Europe, he says, primarily due to the large universe of dividend payers in the region and the fact many of these companies derive a portion of their revenues and profits outside Western Europe.

Ruff likes the major pharmaceuticals, especially Roche, and he notes they're throwing off dividends between 3% to 6%. The largest position in the portfolio is in Danieli, an Italian steel making equipment manufacturer that he says has strong competitive advantages and a yield of 2.25%. Among Ruff's other favorites is EFG International, a $2.5-billion Swiss private bank with an anticipated future yield of 2%, which he says compares favorably versus other private banks. Another of his top picks is EVS Broadcast Equipment, a Belgian producer of professional broadcast equipment used primarily for sports coverage that sported a $5.5% yield.

Among the risks of overseas investing--whether directly through an American depositary receipt (ADR) or a mutual fund--is currency risk. "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," says Josh Peters, editor of Morningstar's Dividend Investor newsletter. "It's usually paying dividends in euros. If the euro falls relative to the U.S. dollar, then your income from that company is going to shrink."

 

Taxes should be another consideration, Peters warns, as many foreign countries levy withholding taxes against dividends paid to foreign investors. And unlike U.S. dividend payments, which tend to be predictable quarterly payments in cash, dividend payment practices abroad are not always consistent. Annual payments are more likely the norm, especially in Europe. "If the firm's earnings drop, the dividend will drop," Peters says.

But not everyone favors the American method. "We don't necessarily like the U.S. approach to paying dividends," Ruff says. He notes that U.S. companies regularly set quarterly dividends, but if they get into a period of weakness where they have to lower that dividend, or the market anticipates them lowering that dividend, the downward price action in the stock can be extensive.

"With foreign companies the dividend policy is often expressed as a payout ratio or a proportion of earnings," Ruff says. "Thus a reduction in the dividend as a result of a mild decline in earnings does not create as much volatility in the stock's price."

Ruff notes that U.S. dividends have increased recently, but have not been restored to levels before the '08-'09 downturn.

And so rests the allure of foreign equities that pay fatter dividends. "Dividends have historically been a major component of total return for long-term investors," says Franklin Templeton's Lisa Myers. "In fact, dividend income and reinvestment of dividends have comprised nearly 70% of global equities' [returns] over the last four decades. So dividends have been very important for long-term investors, and while often overlooked during very strong periods of growth, we expect dividends always will be a substantial part of long-term market returns."