DRIP investors now have the ability to invest in literally hundreds of foreign stocks, to go along with the hundreds of US companies offering the plans, says Charles Carlson of DRIP Investor.
The benefits of investing overseas are several:
- An ability to improve a portfolio’s diversification.
- An expansion of an investor’s opportunity set for finding winners.
- An avenue for taking advantage of economies that are growing faster than the US
To be sure, investing overseas is just like investing in US companies—success depends on finding and buying the right stocks. To that end, this article will help pinpoint some of the best opportunities in foreign DRIPs. But first, let’s go through some of the nuts and bolts of overseas investing in DRIPs.
The ability to buy individual foreign stocks was made easy with the advent of American Depositary Receipts, otherwise known as “ADRs.” ADRs are securities that trade on US exchanges and represent ownership in shares of foreign companies.
Investors buy and sell ADRs just as they buy and sell US stocks. ADRs are quoted in US dollars and pay dividends in US dollars. And those dividend payments, in many cases, receive the preferential tax treatment (currently 15% maximum tax rate) afforded qualified dividends paid by US companies.
Reflecting investors’ appetites for international investing and the increased ease of investing overseas via depositary receipts, global depositary receipt trading volume has skyrocketed in recent years. Annual trading volume in depositary receipts has increased fivefold since 2002, with some 150 billion shares traded in 2010.
One point worth mentioning about ADR dividends is the frequency with which the dividends are paid. ADRs typically pay dividends either annually or semiannually. Thus, investors who require more regular cash flow from their investments, such as the quarterly payment schedules offered by most US companies, may be turned off by the infrequent dividend payment schedules.
Also worth noting is that dividends will be impacted by currency exchange rates, so future dividends can fluctuate significantly.
Finally, a portion of dividends paid on ADRs may be withheld for foreign tax purposes, although investors can recoup that money by filing for a foreign tax credit when they file their taxes.
This foreign dividend tax issue may seem complicated. However, I have owned foreign dividend-paying stocks and can assure you that the tax implications of owning them are really no big deal.
Investing in ADRs does expose investors to some unique risks:
- Currency risk. During periods of a declining dollar, overseas firms generally benefit, since their profits are puffed up when converted to weaker dollars. Conversely, a strong dollar usually crimps returns from foreign investments.
- Political risk. How foreign countries are governed can have a huge impact on the financial well-being of that country. Are the countries rooted in democracies and market-based solutions for economic and social problems? Or is political power concentrated in a ruling elite? Obviously, the social unrest in the Middle East and parts of Europe ups the risks to those markets, especially as it relates to stability of their economies.
- Volatile commodity prices. Many countries, such as Russia and other emerging markets, have commodity-dependent economies. If commodity prices are volatile, commodity-dependent economies and stock markets will likely be volatile.
- Unstable economic policies. Hyperinflation has plagued many foreign countries over the years. While it can be argued that some emerging markets have done a better job of dealing with inflation in recent years, the risk of inflationary monetary policies still exists.
Another economic problem that continues to concern investors is the massive government deficit spending of many foreign countries, and the resultant fragility of foreign credit markets, most notably in a host of European countries.
With several European countries now facing strict austerity measures, economic growth could suffer. That could spell trouble for corporate profits in those countries as well as for firms that export to Europe.
International investments were hit hard during the 2008 market decline. And though foreign markets rebounded in 2009 and 2010, the recent market weakness was especially harsh on some foreign stock markets.
NEXT: The Best ADR Investments
|pagebreak|The Best ADR Investments
Some of the favorites will be familiar to long-time readers of DRIP Investor. For example, Novo Nordisk (NVO), the Denmark-based provider of diabetes treatments, has been a long-time favorite.
The stock has been quite rewarding for shareholders, as these shares have risen more than sixfold since 2000. Diabetes is a major global health problem, so demand for Novo Nordisk’s products should continue to grow.
The stock is rarely cheap, but these shares usually provide a decent entry point for patient investors. I would have no problem buying the stock now and accumulating more shares on weakness.
One of the more interesting growth stories among the ADRs listed here is ARM Holdings (ARMH), a United Kingdom-based company. ARM’s business model involves the designing and licensing of semiconductor intellectual property (IP), rather than the manufacturing and selling of actual semiconductor chips.
The firm licenses its patents to a network of companies that utilize ARM designs to create and manufacture system-on-chip designs, paying ARM a license fee for the original IP and a royalty on every chip or wafer produced.
Over 15 billion ARM-based chips have been shipped to date. ARM technology is used in more than 95% of the world’s mobile handsets, and over one-quarter of all electronic devices.
Profits have been rising for the firm. Per-share profits should jump around 16% in 2011, and more than 20% in 2012.
These shares have been a favorite of technology investors, which is evident from the stock’s lofty P-E ratio of 52 times 2011 earnings estimate. Thus, the stock is vulnerable to a downturn in the overall market and the tech sector in particular.
Still, the company has its tentacles into some of the most exciting growth markets in the tech sector and represents an intriguing play for more aggressive investors looking for foreign tech exposure.
The telecom sector represents another interesting area for overseas investment. Two attractive stocks in this sector are America Movil (AMX) and China Mobile (CHL).
America Movil, based in Mexico, is a leading provider of wireless services in Latin America. The firm is broadening its business with the acquisition of the remaining 40% interest it does not already own in Telefonos de Mexico, a wireline provider of telecom services.
China Mobile, with 627 million customers, is the world’s largest provider of mobile telecom services.
Both firms should experience above-average growth. Both also offer nice cash flow in the way of dividends. China Mobile’s yield of 4% is especially attractive.
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