At 4.9%, the French company Total SA (NYSE:TOT) sports one of the best dividend yields of any of the Big Oil companies, making it a very intriguing opportunity for dividend investors. There's just one problem: Total is an ADR and comes with foreign withholding taxes that can wipe out a fair bit of those dividend gains over time. Let's take a closer look.
An American Depositary Receipt, or ADR, is a certificate issued by an American bank that represents a certain number of shares of foreign stock. From the individual investor's perspective, buying and selling ADRs happens the exact same way we buy and sell regular stocks.
When it comes to paying dividends, however, ADRs carry one important caveat: They are subject to withholding taxes in their home country. Tax rates can range from 0% to 35%, depending on the country, and it's crucial for investors to understand how that can impact their returns.
What this means for Total
To get a feel for the effects of foreign withholding we'll consider a full-year of Total's price and dividend performance. Here's the company's story from 2013:
Its price climbed 16.5% from January through December, or $8.70 per share, while dividends paid through the year totaled $3.179 per share. The total return, then, was about 22.5%. Now let's factor in foreign withholding.
France's withholding rate on dividends paid to U.S. ADR holders is 30%. Remember, France will tax these dividends before they even reach your brokerage account. Applied to shares of Total in 2013, the total dividend payout factoring in withholding is $2.225, dropping the total return from 22.5% to 20.7%.
That might not seem like a big difference, but remember that's for just one share over the course of one year. That difference will be magnified if you hold many shares over the course of many years. Ultimately the biggest loss is the one that happens over time, through the power of compounding.
Let's look at what would happen if we took the dividends from 100 shares of Total, compounded annually at the historic market rate of 6.5%, over the course of 25 years.
Again, the difference in one share is a few cents, but when you look at more realistic numbers, a few cents quickly turns into hundreds of dollars over time.
Come back, money!
There is one way to potentially recoup at least a portion of these losses. Investors can file for a foreign tax credit when they do their taxes every year. That said, this only covers up to 15% of foreign withholding, and only if the ADRs are held in a taxable account. If your shares are in a tax-deferred account like an IRA then that money is gone forever.
All of this isn't to say that foreign companies like Total are not worth owning. Its dividend after taxes may still be better than another stock you are considering, and it may still outperform other dividend stocks -- that 16.5% rise in stock price is obviously worth something. Rather, the real danger is in buying a stock like Total as part of an overarching dividend strategy, not realizing that its true yield may be hampered by foreign taxes.