Dividends Make A World of Difference in Global Markets

David Nadel

As U.S. investors, do we view dividends differently than non-U.S. investors? How much common ground is there?

There are many differences, but investors the world over do view dividends as a measure of a company's quality. Think about it: if a company has increased dividends 42 years in a row, as Spirax-Sarco, a U.K. based maker of industrial steam products has done, they are probably doing something pretty well with their business.

In the U.S., however, we tend to have a much different view of dividends than do investors abroad. American investors typically think of dividends as an afterthought, and tend to be more focused on capital appreciation, particularly when it comes to small-cap stocks. Here, dividends are associated with mature companies that are cash generative, but that have limited growth possibilities and limited options for investing fruitfully in their own business. U.S. investors see them as almost sleepy companies – "widow and orphan" stocks for people looking for yield.

By contrast, dividends have a much more positive connotation outside the US, both among small-cap companies, and among their investors. It almost requires a bit of a leap of faith for American small-cap investors to open up to this concept that dividends are viewed this differently in other countries. First of all, dividends abroad are not exclusively the province of large-cap companies. Companies of all cap sizes pay dividends. And it's not just mature companies which pay, but rather fast-growing companies pay dividends, too. In the U.S., small-cap growth companies here tend not to pay dividends, opting instead to invest in the business, do acquisitions, or even buy back stock. Abroad, smaller companies may do any or all of these things, but in any case they typically return some portion of their net income to shareholders in the form of dividends.

The incidence of international small-cap companies paying dividends tends to be considerably higher than that of their US counterparts. Anecdotally, when we travel abroad to meet with companies, generally upwards of 80% of those companies have a dividend policy and a consistent track record of returning earnings to shareholders.

How does that get represented in the non-U.S portfolios you manage?

Looking at the portfolio of Royce Global Dividend Value Fund, all of the Fund's holdings pay dividends, which may not be a surprise because of the fund's stated investment objective. However, what's interesting is that the percentage of dividend payers is likewise fairly high among all of Royce's global and international funds.

Although most investors are accustomed to looking at dividends per share, you focus more on dividend payout ratios when assessing dividend paying stocks in non-U.S. markets. Why do you focus on payout ratios rather than dividends per share? 

The dividend payout ratio—the ratio of dividends to net income—is what is typically used in foreign companies. Typically, a company's management states a policy to pay a fixed portion of net income back to shareholders. It's really an enlightened idea that to us underscores good corporate governance. For small company stocks in non- U.S. markets, you routinely see 35%-40% payout ratios. Australia, Britain, Canada, Hong Kong, and Switzerland for example, all markets in which we are interested, have dividend payout ratios of 47.0%, 39.8%, 34.5%, 40.1% and 41.7% respectively. (Source: Bloomberg)

By contrast, investors in smaller-company US stocks tend to get a dividend payout which works out to closer to 25% of net income, when they are fortunate enough to get a dividend.  And the notion of a company paying out a fixed portion of their net income is just not something we are used to here. American companies talk about dividends per share, and investors talk about dividend yields, but I think it makes more sense to focus on the dividend payout ratio, because it links dividends to earnings, and all investors in theory at least should have a claim on earnings.

In countries where dividends are so valued, is it a calamity when a company cuts its dividend?

Typically, it is less of a calamity than it is here. Obviously a dividend cut is not a positive in and of itself. However, because non-US companies tie their dividends to net income via the dividend payout ratio, investors understand that the absolute dividend will fluctuate with earnings. And foreign companies rarely eliminate their dividends entirely. I think in general, when a U.S. company cuts its dividend, investors here take it more personally, because the universe of dividend payers is much narrower and so investors in those companies are really counting on that dividend. So in the US, a dividend cut is a bad signal.

Is this emphasis on dividends abroad purely an altruistic stance?

No. There's more to it than altruism—it can also be self-serving. In general, foreign small-caps are in an earlier stage of their corporate evolution than their US counterparts, and so many of these foreign companies are still family controlled. Very often, the family likes the income of that predictable dividend stream. They depend on the dividends for cash flow, and prefer receiving a dividend to selling shares for profit as U.S. managers typically do. But as minority shareholders, we benefit from the way foreign small-caps do commit to returning money to investors.

Are reinvested dividends a key component in compounding? 

Absolutely. And the positive impact is often under-appreciated, particularly for long-term investors, like the folks who invest in Royce Funds. These days, dividend yields from equities exceed the yields available from bank savings accounts by a factor of 2-4 times in the developed foreign markets, albeit of course with more risk to principal than a savings account. Compounded over the long term, the results of holding dividend-paying equities are quite remarkable. For example, in the case of UK companies, dividends have accounted for 31% of the market's total return since 1969.  Dividends giving you nearly one-third of your total return over a 42-year period -- you can't dismiss dividends as an afterthought!