Finding Foreign Dividends in Exotic Locales

This article published with permission from InvestmentU.com.

Like a hungry predator, investors are on the prowl for yield. Many quality companies that were yielding 4% or 5% a year ago now have dividend yields below 4%, as prices have been bid up on nearly any stock with a respectable dividend.

As a result, investors are forced to look in some more exotic places. Real estate investment trusts (REITs), business development corporations (BDCs) and especially master limited partnerships (MLPs) have all gained popularity over the past year.

One area that has been a bit overlooked is foreign dividend payers.

There are quite a few American depositary receipts (ADRs) that pay a decent dividend —

often more than their American contemporaries. However, you need to keep a few things in mind.

The dividend isn’t always paid quarterly. Most American companies that pay a dividend do so on a quarterly basis. However, foreign companies sometimes pay only twice a year or even just once annually.

Currency fluctuations may alter the amount of the dividend per ADR that you receive. The company usually pays its dividend in the local currency. If you’re invested in a Brazilian company, management will think about and pay its dividend in terms of Brazilian reals, not dollars. Any yield consideration will be based on its share price trading on the Bovespa (the Brazilian stock exchange). Holders of the ADR will also receive a dividend, but it will be dependent on how much was paid in the local currency and the exchange rate.

A Brazilian company could keep its dividend payment constant from one year to the next, but if the real depreciates in price, you’ll get fewer dollars. If the real appreciates, you’ll receive more dollars.

Therefore, for investors who prefer companies with a steady history of dividend growth, foreign ADRs may not match those objectives perfectly.

But that doesn’t mean there aren’t interesting income opportunities in foreign markets. As long as you can handle the currency fluctuations and the irregular payments, the yields are attractive enough to make it worth your while to take a look at some.

For example, CSN (NYSE: SID) is the sixth-largest steelmaker in the world. Based in Brazil, it earned R$2.9 billion in the first three quarters of 2011 and paid R$1.9 billion in dividends. The company pays its dividend in May and is expected to yield about 6% based on the current price.

Another Brazilian company with a healthy dividend is CPFL Energy (NYSE: CPL), the country’s largest privately owned energy company, with 13% of the national market. Roughly 75% of CPFL’s revenue is regulated, which means the company’s cash flow is rather predictable. That should give shareholders confidence that their dividend is secure. As long as Brazil’s economy continues to grow, so should its dividend.

CPFL generated R$2.3 billion in cash flow from operations over the last 12 months and paid R$1.3 billion in dividends. It’s expected to yield 5.5% on today’s price.

Don’t forget to pay Uncle Santos

Often, when you receive dividends from a foreign company, taxes will be automatically taken out of your dividend payment. Since you already paid taxes on those dividends to the foreign government, the IRS will not make you pay it again. In fact, it will give you a tax credit against your U.S. tax obligations.

So, if you earned $1,000 in foreign dividends and paid $250 in taxes to Brazil, for example, you would be entitled to a $250 tax credit on your U.S. taxes.

Of course, when it comes to taxes, be sure to consult a professional tax adviser with any questions.

There are plenty of other foreign companies with juicy yields. You have to do a little bit of work in order to understand the story. But to feast on yields that in some cases are double what their American counterparts are paying, it’s worth putting in a little elbow grease. Your portfolio will thank you.

Marc Lichtenfeld is the Senior Analyst at InvestmentU.com. See more articles by Marc here.