Most retail equity investors have what is known as a ‘Home Bias’. Simply put, they have an emotional preference for investing in companies that are listed in their home market, and are uncomfortable investing overseas.
This bias hurts all investors regardless of location, but US dividend income investors are especially compromised by staying local. Since the NASDAQ’s inception in 1971, it would seem that the tech sector payout model has slowly ‘infected’ the broader US equity market. Tech companies generally reinvest all earnings or distribute negligible amounts to company owners. Unfortunately, over the past 30 years this trend has slowly replicated across the broader US equity market.
Low Payout Ratio. Low Yield
From 1982 – 2011 the S&P 500 Payout Ratio fell from 50 to 30%.As of Q3 2011 it stood at 28%
From 1982 – 2011 Average Yield on the S&P 500 fell from 5.5 to 2%. As I write it is 1.92%
Rebounding from 2008/09, S&P 500 corporations recorded the biggest increase in profitability since 1900*. The 12-month EPS for the index is $94.77, surpassing the peak of $91.47 set in 2007. Despite record profits, investors in US corps are not seeing a lot of cash. They are choosing either to hoard their cash, pursue M&A activity, or repurchase their own shares. Their return to profitability has not altered the long term trend of lower payouts and lower yields. The problem is structural, not fiscal. The changing demographic as baby boomers approach retirement may force management to refocus on distributing income, but the 30 year trend will be slow to reverse. Disney(DIS) boosted their dividend by 50% in 2011. Even with the hike, DIS current yield is still only 1.52%**. DIS’s payout ratio? 15.73%.** Wal-Mart(WMT) current yield =2.39%**. WMT payout ratio = 31%,** reflecting the S&P average. Despite record profitability, large established US corporations with long histories of profitability, are choosing to retain large portions of their earnings. Compare this to other markets:
ASX 2011 Payout ratio = 70%
ASX 2011 Average Yield = 4%
FTSE-100 2011 Payout ratio = 50%
FTSE-100 2011 Average Yield = 3.85%
Most other major European markets are in line or exceed UK levels. Out of all the developed markets outside the US, currently only Japan’s yields are lower. For this reason alone US dividend income investors should consider reaching beyond their home bias for more meaningful yields. The US Bank Sector, formerly a major high yielding sector, has slashed or suspended dividends since 2008, narrowing US equity investor’s yield search to just a few sectors: Utilities, Telco’s, Consumer Staples, REITs, and Pipelines. To both diversify and increase their yield, US dividend income investors need to go global.
Go Global – What does that mean exactly?
Global in this context does not mean extra yield for added risk, or exposure to emerging markets. It refers to large companies with long histories of profitability and dividend increases. It means investing in companies whose management is still focused on redistributing growing income streams to company owners. I am referring to companies listed in the established, highly regulated markets of Europe and Asia. Fortunately for US investors many of these global titans also have an ADR listing, with many reporting and paying dividends quarterly – in US dollars. Diversifying across market sectors globally also allows income investors to select best of breed stocks. Unlike Verizon(VZ) and AT&T(T), Spain’s Telefonica (TEF) and UK Vodafone (VOD ) are global Telco’s, deriving their earnings from a global geographic footprint.
TEF current yield = 10.63%**
VOD current yield = 5.14%**
Diversifying globally can also mean reducing risk non-conventionally. An example of this could be allocating capital to sectors with a higher degree of regulation than available in the US. Consider the high yielding Canadian banks vs US Banks. Canadian banks are regarded as the world’s safest ¹, required no government bailout during the GFC, with 5 out of the 6 largest Canadian banks actually increasing their dividends through 2008/09. Even with US financials return to profitability compare current yields of BAC (0.57%), JPM(2.68%), WFC(1.57%) to Canadian RY(4.0%),BNS(3.83%), BMO(4.68%). Diversification across the US bank sector would not have saved a US income investor in 2008/09. Bank stocks got clobbered worldwide in the GFC, but many Australian, Canadian, and Asian banks continued to pay dividends through this period. By 2011 the same 6 Canadian banks’ payouts had exceeded 2007 levels. 4 out of the six are currently trading above their 2007 peaks. The US Bank sector has yet to recover fully.
As the above data would indicate the problem at US corporations is not one of profitability – historic or current . The problems appears to be more one of the management culture embedded in boardrooms. By contrast, large global businesses headquartered in Europe/Asia remain focused on distributing profits to company owners. Home bias can be seen as a kind of misplaced loyalty. But that loyalty is not being rewarded by US corps. US income investors who reject income stock candidates because of a home bias are simply reducing their opportunities by saying no to quality income streams outside their home market. Consider Reckitt Benckiser(RB), the UK based consumer staples giant who derive roughly 50% of its sales outside its European home market. Proctor & Gamble(PG) also gets 50% of its sales outside its home market. What differentiates RB.L from PG?
PG – EPS 5 Yr. Growth Rate: 9.95% / Dividend 5 Year Growth Rate: 11.37%**
RB – EPS 5 Yr. Growth Rate: 18.89% / Dividend 5 Year Growth Rate: 24.14%**
All other things being equal, which one of the above would you choose? RB seems to be growing its EPS/dividend at roughly twice the rate of PG. Would you reject RB on the grounds it is ‘foreign’, even though you may use and trust it’s products every day. It just doesn’t make sense to be global as a consumer and parochial as an investor.
To sum up.
Dividend Income investors in US corporations are naturally disadvantaged by significantly lower payout ratios and current yields than those offered in other developed markets. Further, this phenomenon appears to be structural rather than cyclical.
Diversification across sectors globally can reduce risk and allows ‘best of breed’ selection.
Most overseas large caps have a US ADRs listing. In addition, for transparency, most of the largest ADRs financials are reconciled to (GAAP), with the SEC as regulator of the Company’s disclosure to investors.
Note: Many countries allow dividends to be paid out free of withholding tax. This includes UK, Brazil, Hong Kong, Singapore, South Korea and India. In addition many Australian dividends are paid out as 100% franked i.e. free of withholding tax for overseas stockholders. This makes high yielding stocks from the above countries ideal for US retirement accounts.
*** Motley Fool. www.fool.com
¹ Global Finance – WORLD’S 50 SAFEST BANKS 2011