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Many investors focus almost exclusively on the domestic market. This bias is understandable, since U.S. citizens know more about their home market than they do about the many international markets in which they could invest. However, this bias could be limiting, particularly when considering dividend-paying companies. Some of the largest, most diversified companies in the world are domiciled overseas, possess great long-term prospects, and possess handsome dividend yields.

For example, Unilever (UL) is one of the world's largest producers and marketers of branded and packaged consumer goods, with businesses in 100 countries. The dividend yield on the stock was recently about 4%. This compares favorably to Kraft Foods Inc. (KFT Free Value Line Research Report for Kraft), which is the largest branded food and beverage company headquartered in the United States, and the second largest worldwide. Although Kraft is in the middle of breaking itself apart, complicating the comparison, Kraft shares recently yielded about a percentage point less than Unilever.

For an investor seeking income, the yield edge that Unilever has over Kraft could make a big difference. However, it’s important to understand the pros and cons of buying foreign stocks. In the end, the pros probably outweigh the cons, but the outcome of the balancing act is in the hands of each individual. Here are some issues to consider:

Access to Shares

It is very simple for a U.S. investor to buy domestically listed companies. Buying shares in foreign companies can be a bit more complicated. The easiest way is to buy American depository receipts (ADRs) or shares (ADSs). These, however, are not usually direct investments in the company the shares represent; A bank or other entity is usually acting as a middle man. The middle man holds the actual shares and lists an ADR or ADS that represents the shares it holds. The bank gets paid for this service. More importantly, the ADRs or ADSs may represent a fraction or multiples of an actual share of the company as it trades in its home market. This is an issue that investors should be aware of and understand before buying shares. Another issue to consider is that some foreign companies do not have shares listed on large domestic exchanges, instead relying on the so-called Pink Sheets for their listings. Although there is usually adequate liquidity for larger companies, smaller ones may not have the same liquidity.

Legal Recourse

Foreign companies are governed by the laws of their home country. This can be true for investments in their shares, as well. Thus, U.S. investors may not have the same protections when investing in a foreign company that they would when investing in a domestic company. Moreover, any kind of recourse could be quite difficult for a small investor located in the United States since access to foreign legal systems and experts would likely be limited.

Exchange Rates

The value of the dollar versus other currencies, such as the euro, changes on a second-to-second basis. This is true of all currencies in comparison to each other. These changes can affect the results of foreign companies, which often do business in more countries than those focused on the relatively large U.S. market. Exchange rate fluctuations will influence financial results as country results get consolidated, the level of the dividend, and, in many cases, the actual level of the domestically listed stock (depending on how the stock is listed on the U.S. exchanges). Exchange rates aren’t always a negative; in fact they are likely as often positive as they are negative. However, the fluctuations here can create added volatility to share prices and dividend disbursements.

Accounting Differences

While investors in the United States may be very used to domestic generally accepted accounting principles (GAAP), foreign companies may report their financials using different standards. This can cause some confusion, as their measures, which may or may not have similar names, can differ from what U.S. investors are used to seeing. A large number of companies listed on U.S. exchanges translate their reports into U.S. GAAP, however, so this may not be as big an issue for those entities. That said, it is important to keep an eye on this issue to avoid confusion.

Diversification

The United States is a relatively large and mature market. Companies could operate quite profitably for years addressing only the domestic market without ever needing to move to the international space. Most foreign markets don’t enjoy the size and diversification of the U.S. market. Thus, working across borders is a normal part of most foreign businesses—this is not as often the case in the United States. This affords a sort of built in level of diversification and, perhaps more importantly, experience.

Dividends

There are a number of dividend related issues for domestic investors to consider. First, many foreign companies have more generous dividend policies than their U.S. counterparts. This is not, of course, a universal statement, but does suggest, as shown by the Unilever/Kraft example above, that dividend-focused investors only investing in domestic stocks could be short changing themselves.

That noted, foreign companies often pay dividends only twice a year, one small (interim) payment and one large (final) payment. For an investor trying to live off of his or her dividends, this payment structure could be hard to work around. Assuming a regular flow of income from other sources, however, an investor could view foreign dividends as a way to pay for less frequent costs, like taxes, travel, or holiday spending.

Complicating the dividend issue is the fact that dividends from foreign companies are often variable based on business performance. Thus, dividends can fluctuate wildly from period to period. While this allows shareholders to benefit when a company is doing well it also means that they “participate” when a company is not doing well. Moreover, since the payments often only occur two times a year, there could be some additional stress while waiting to find out just how much a disbursement will be.

Foreign nations are just as tax conscious as the United States. As such, the dividend a company pays may not be what a U.S. investor will get, since the foreign government will want its piece of the pie up front. This will likely result in two line items for a dividend on an investor’s brokerage statement, one for the dividend and the other for foreign taxes withheld. Those withholdings, however, can be reclaimed, to some extent, on an investor’s U.S. taxes come April 15th. It is advisable to consult a tax specialist on this matter, but it is important to note that the dividend an investor receives is likely to be smaller up front than expected based solely on the stock’s yield.

These are a few of the more important issues a U.S. investor needs to consider before stepping into foreign shares. The decision is probably less onerous than it seems, but it is important to understand the differences before you make a purchase. To use a tangible example, driving is similar in just about every country. However, if you were to drive on the right side of the road in Great Britain, as you would do in the United States, you would be on the wrong side of the road for that country. A subtle, but incredibly important difference. 

At the time of this article’s writing, the author did not have positions in any of the companies mentioned.