Ah! The undeniable appeal of a foreign stock. Not only do these stocks originate in exotic sounding locations but some of them pay a pretty decent dividend. Some, in fact, pay higher than the S&P 500 average.
These stocks are known as American Depository Receipts or ADRs. Basically, these are stocks listed in USD on an American stock exchange that you, the average investor, can buy and sell as usual.
Some of these are household names and are well-recognized. Multinational companies from other developed countries may have already made a mark on the local market. For example, who hasn’t heard of Vodafone, BP, Total or Canon?
While investing in international stocks isn’t necessarily easy, some stocks could make it worth your while by compensating you with a higher dividend. Here’s what you need to know:
The obvious advantage of buying foreign ADR dividend stocks is the diversification. Owning a portfolio of stocks that spans multiple countries could be the best way to safeguard against a sudden shock in the US market.
It could also guard against political uncertainty and economic headwinds in America.
Another advantage is the higher dividend rate paid by many of these foreign dividend stocks. Some of these ADRs offer investors a juicy piece of the high growth emerging market. HDFC bank, for example, is one of the largest private banks in India. India’s the fastest growing economy in the world.
Meanwhile, dividend stocks from developed European countries offer a stable return and healthy dividend. Vodafone, a British telecom company, pays a dividend yield of 6%. Other big dividend stocks include British Petroleum or BP pays out a whopping 7%. SSE (SSEZY), a British energy company, pays out nearly 8%. Similarly, Spain’s Telefonica pays a 7% dividend yield.
These are, no doubt, excellent dividend yields from some high quality foreign companies. But these stocks come with certain downsides.
We’ve discussed qualified dividends for tax purposes before. American income seeking investors who stick to American stocks can easily figure out how much they owe in taxes at the end of the year. Tax regulations are a bit different for foreign stocks like these.
Foreign dividends count as foreign income as far as the IRS is concerned. This means you may have to claim back foreign taxes as tax credits in your tax returns, but this is a complicated process. You may have to file taxes for the stocks separately in each country where you own the stock, but most countries have special treaties that prevent this. These treaties offer preferential treatment to US investors to avoid double-taxation. Although the US doesn’t have such treaties with every country. Other countries will simply withhold the tax at source, which will have an impact on the final yield you get.
Taxes are complicated, but if you do your research and figure out the after-tax yield, some foreign ADRs might still be attractive dividend investments.
Foreign stocks might be a great way to diversify your dividend stock portfolio. If you pick blue chips from developed countries and stable economies, you could lock in a higher dividend yield.
However, currency, regulations, and taxes could prove to be pitfalls for a lot of ADR investments. Do your research before you take the plunge.