Buying shares for income has traditionally entailed investing in sectors that economically aren’t going anywhere.  U.S.-focused investors find themselves owning railroads, trucking companies and electric utilities, not the most exciting of sectors, and most unlikely to grow your investment as a percentage of the global economy.

Even in those so-called “tried and true” sectors, in the modern U.S. economy of huge payouts, stock options and multi-millionaire management, you aren’t likely to get the dividends you deserve. For example, the railroad company CSX Corp. (CSX) yields 1.5%, trucking company J.B. Hunt Transport Services Inc. (JBHT) yields 1.0% and even electric utility American Electric Power Co. Inc. (AEP) yields a modest 4.3%.

All three companies pay out less than half their earnings. The remainder is retained in the company, or used for share buy-backs, to provide capital gains for top management’s greedy stock options. If you can’t get decent dividends from investing in these admirable operations, dividend investing in the United States is a lost cause.

But internationally, income investment is a horse of a different color.

First, international firms don’t follow the Wall Street model of huge salaries, generous stock options and seven-figure bonuses. Less money earmarked for executive compensation means more cash in investors’ pockets.  And that’s a good thing, because international investors have a natural cynicism about retained earnings, believing that money that stays with the company is just management’s to waste. It’s much better to have the excess cash paid out in dividends, to do with, as you like.

Second, foreign markets are growing much faster than the United States. If the local economy is growing at 7% to 10%, even the railroads and electric utilities will grow at a similar pace, providing an increasing stream of profits.

Third, you don’t need to confine yourself to companies growing at the speed of an arthritic snail to get good dividends or sacrifice the capital gains that come from investing in sectors that provide the world’s new ideas, intellectual growth and economic advance. Unlike the technology firms in the United States, some international companies in growth sectors don’t feel they have a God-given right to keep ALL the earnings under management’s control. Instead, they pay out dividends to shareholders.

The international appeal of dividends makes more sense when you remember that many of these companies are still controlled by the founders or their immediate heirs. Large dividends on their holdings are understandably attractive to these rich founding families.

Furthermore, in some countries such as Taiwan, the tax system rewards paying dividends, by imposing an additional “retained profits tax” on companies that keep too much of their earnings without making good use of them.  (The United States had a similar tax from 1936 to 1958, but the management lobby proved stronger than the investor lobby, so it was repealed.)

Internationally, you can find what seems impossible in the United States: Companies in growth sectors, with good track records, that nevertheless pay out good dividends, at least at the 4-5% level and sometimes more. By investing in such companies, investors can have the best of both worlds:

• A substantial dividend that they can live on.
• And the chance of capital gains in the future as the company expands.

It’s almost like U.S. investing in the halcyon days of 1949, when the Dow Jones Index had a Price-Earnings (P/E) ratio of 7% and a 6.9% yield (U.S. Treasuries yielded less than 3% at that time). And while we can’t go back in time, by investing internationally and picking carefully, we can get some of the advantages of an investor in 1949. And even possibly do as well as that investor did during the subsequent decade of Eisenhower growth and stock price rises.

Here’s how to “have it both ways,” when it comes to international income investing:

Administradora de Fondos de Pensiones Provida SA (ADR: PVD), commonly known as Provida, is the funds manager of the privatized Chilean social security funds, a business it has diversified to hold investments in fund administrators in Peru, Ecuador, Mexico and the Dominican Republic. Majority owned by the Spanish bank Banco Bilbao Vizcaya Argentaria with a P/E ratio at 9 times trailing earnings, and a dividend yield of 7.6%, this stock is especially juicy for income investors. Growth will likely come from increases in assets under management, as Chile becomes richer and some expansion of the Chilean pension fund model to other countries.

Acer (Taiwan) (London Stock Exchange: ACID) is the world’s third largest manufacturer of personal computers, with top technological innovation in Taiwan and the ability to manufacture in the cheap-labor rural China. P/E ratio 12 and a dividend yield of 5.6%, plus you get to participate in the growth of the PC industry.

Eni SPA (ADR: E) is Italy’s entry in the “Big Oil” stakes. Because of Italy’s neutral foreign policy posture, it has the advantage of being able to operate in countries like Kazakhstan, Libya and Venezuela where U.S. companies have difficulty. At a price-earnings ratio of only 6.7 with a dividend yield of 6.6%, it currently offers excellent value with chances for growth if oil prices stay high and new oil sources remain attractive.

[Editor’s Note: When it comes to global income issues, Money Morning Contributing Editor Martin Hutchinson knows his stuff.  An investment banker with more than 25 years’ experience, Hutchinson has worked on both Wall Street and Fleet Street and is a leading expert on the international financial markets. In February 2000, as an advisor to the Republic of Macedonia, Hutchinson figured out how to restore the life savings of 800,000 Macedonians, who had been stripped of nearly $1 billion by the breakup of Yugoslavia - and then the Kosovo War. Hutchinson’s “Insights on Income” column is a regular feature in Money Morning].

Source: Insights on Income: You Don’t Have to Sacrifice Capital Gains for a High Yield

In concrete figures, of the world’s $11.8 trillion of manufacturing value added output expected to be produced in 2009, China will account for 17%, while the United States will account for 16%.

For investors, even those based in the United States, the implication is clear: a substantial part of any investor’s portfolio should be in China and any other countries where manufacturing is growing as a percentage of the world total.

China’s manufacturing share has been accelerating rapidly since 2000, when it accounted for only 7% of global value added. Back then, the United States accounted for around 25% of the total. China’s growth spurt in the last year has been caused not by any special acceleration in China’s growth, nor is it the product of a sudden collapse in the U.S. manufacturing economy. The decline in the dollar – and the rise of the Chinese renminbi against the dollar – is what has inflated the value of Chinese manufactured goods.

For the United States, economic theory suggests there is no need to panic. Most services have at least some component of local supply, so they cannot be outsourced easily overseas (the exceptions being such services as computer software or accounting). Hence, it is natural that richer countries will tend to specialize more and more in the service sector, while poorer countries become more devoted to manufacturing products that can be easily shipped around the globe.

Nevertheless, there are a number of moderately disturbing implications to this news. To the extent that Chinese or other poor-country manufacturers acquire additional capabilities by manufacturing products for Western use, they may become more competitive in the international market against Western companies. Research and development, in particular, require a deep understanding of the production process to be successful – an understanding that is difficult to acquire from a distant country.

For investors, the exciting opportunities are likely to arise in China, and in other low-wage manufacturing countries that are opening up to Western markets. There are also opportunities in countries, such as Taiwan, that have the ability to marry their own technological capabilities with low wage manufacturing in China or elsewhere in Asia.

To take advantage of this trend, you might look at the following companies, all of which stand to benefit from the move of global manufacturing to China and other low-wage economies:

• Acer Incorporated can be bought through London depositary receipts (LSE: ACID), which are liquid and quoted in dollars. Acer became the world’s third largest manufacturer of personal computers after buying Gateway last year. It manufactures in cheap-labor China, but has top quality Taiwanese research and design and good relations with Taiwan Semiconductor Mfg. Co. Ltd. (ADR: TSM), the world’s largest chip manufacturer. Acer yields 12% on a historic basis, but some of that relates to a special dividend on real estate profits; on the basis of its regular dividend its yield is about 7%. Its forward Price/Earnings ratio is 11.

• Dr. Reddy’s Laboratory Ltd. (ADR: RDY) is India’s premier manufacturer of generic pharmaceuticals, poised to benefit in the 2008 – 2012 period as many popular drugs lose their patent protection and are opened to international competition. It has moderate debt, about 50% of equity, and is also selling at a multiple of 17 times earnings to March 2009, with a dividend yield of only 0.8%. Again, the relatively high rating reflects the growth potential in Dr. Reddy’s global business, which benefits from low cost and high quality in India.

• Aluminum Corp. of China Ltd. (ADR: ACH) is an integrated aluminum smelter focused on the Chinese market. It thus benefits from the rapid growth of Chinese manufacturing, as well as rising commodity prices generally. ACH is currently trading at a very reasonable P/E ratio of 7.6 times estimated 2008 earnings, with a dividend yield of 3.3%.

Source: China Points the Way to Profits as the New Global Manufacturing Leader

If you were an income investor, to balance those high yields, you also had to have capital appreciation, so about half your portfolio would be invested in U.S. common stocks – which, thanks to their dividend payouts, yielded a good 3%-4% themselves. Even after you paid Uncle Sam, a portfolio such as this one would have easily thrown off 5% of its value in income, and allowed you to keep up with inflation as stock prices generally rose.

Clearly, those were the halcyon days for income investing.

More than two decades later, income investors face a much bigger challenge. U.S. stocks have posted mediocre results since 2000, while bonds and cash have provided truly lousy returns after inflation and taxes are taken into account. Stocks pay lower dividends than they used to, especially since top corporate executives now are loaded up with stock options, and those decline in value every time a dividend payout extracts a big slug of cash from the corporate coffers.

The bottom line: While stock prices, interest rates, and inflation are at current levels, and U.S. economic growth remains sluggish, income investors who focus only on domestic income investments will be lucky to break even in cash terms after they have attempted to live on 5% of their capital.

There is a solution, however. In fact, this particular income strategy can offer much better returns than anything a domestic income investor can ever hope to find. We’re talking, of course, about investing internationally. Most investors think of the international markets only as another place to seek out stocks. But overseas financial markets are a great option for income investing, as well. And here’s why.

The Overseas Option for Income Investors

• The United States continues to run an annual balance-of-payments deficit of $700 billion. As long as that persists, the dollar will tend to be weak against other currencies. Sometimes, even low-risk investments in the right foreign currency can provide substantial capital gains – and it’s not always the obvious currencies. Did you know you could have made more than 30% in dollar terms during the past year from a bank deposit in Czech crowns? And that wasn’t some wild investing gambit: These days, the Czech Republic is a perfectly solid middle-income democratic European Union member with an admirable free-market president, Vaclav Klaus.

• Because U.S. interest rates are so low, many countries have higher interest rates – with lower rates of inflation. Australian, Brazilian, and New Zealand bank deposits all pay more than 5%. All three currencies have recently been strong against the dollar and will likely continue to perform so. And all three of those economies have inflation rates that are comparable to, or lower than, the United States’ rate of inflation (South Africa also has 8% deposit rates, but there inflation is too high for safety).

• While the U.S. economy scuffles along at a 1% pace – and even if it were to recover to 3% – there are a number of countries with growth rates of 5% or greater, not all of which have overvalued stock markets. China and India famously have growth rates of 9%-10%, but what about South Korea and Taiwan? Both are richer countries with growth rates consistently in the 5%-6% range. By definition, if stocks in those countries are no more expensive than in the United States, they are likely to offer better value.

• Many stocks outside the United States pay generous dividends, often because they are still controlled by the original founding families who want the income, or because these firms are based in companies with are located in countries with good-value stock markets.

International Income Investing: The Secrets of Success

For income investors seeking dividends from international investments, the secret is to find companies with high dividend yields, but which aren’t operating in the kind of risky or highly cyclical business sectors that will make those dividends vulnerable.

In other words, what you don’t want to see is a situation where you buy into a stock for its hefty dividend yield – only to have the board of directors of that company suddenly decide that it needs to conserve cash. For instance, Telecomunicacoes de Sao Paulo SA (ADR: TSP), the fixed-line telephone system in Sao Paulo, Brazil, has a dividend yield of no less than 14%. However the company’s profit margins are under attack by the aggressive cellphone operators in the country and its earnings seem likely to decline. Indeed, the consensus forecast for TSP’s 2008 earnings is about 30% less than the dividend payout, suggesting that dividends will be forced downward – unless the company starts liquidating itself.

Some current recommendations that have good dividend payouts that are also securely covered by earnings:

• Kookmin Bank (ADR: KB): The largest bank in South Korea, Kookmin has a dividend yield of 4.6% and a Price/Earnings (P/E) ratio of less than 8.0. Kookmin has avoided an entanglement in the U.S. subprime-mortgage mess, but has nevertheless been dragged down by investor disillusionment with the financial services sector.
• Acer Inc.: Based in Taiwan, Acer is now the world’s third-largest manufacturer of PCs, with a global market share that reached 10% since its 2007 purchase of Gateway. Although there are several ways to invest in this company, this is best bought through its Global Depositary Receipts, which are listed on the London stock exchange (ACID). Acer has a dividend yield of 6.4% and a P/E ratio of only 11.0 – pretty alluring numbers for a leader in a major growth sector.
• Tele Norte Leste Participacoes SA (ADR: TNE): Also known as TNE, Brazil’s cellphone compay has a yield of 4.8% and is trading at about seven times earnings.

One final note: Income investing is all too often viewed as a stodgy, no-growth strategy for the total risk-averse. But as Acer and TNE demonstrate, you don’t need to confine yourself to stodgy, low-growth sectors to get a juicy dividend yield with good security. You just have to look globally.

[Editor’s Note: When it comes to global income issues, Money Morning Contributing Editor Martin Hutchinson knows his stuff. An investment banker with more than 25 years’ experience, Hutchinson has worked on both Wall Street and Fleet Street and is a leading expert on the international financial markets. In February 2000, as an advisor to the Republic of Macedonia, Hutchinson figured out how to restore the life savings of 800,000 Macedonians, who had been stripped of nearly $1 billion by the breakup of Yugoslavia - and then the Kosovo War. Hutchinson’s "Insights on Income" column will now be a regular feature in Money Morning].

Source: Insights on Income: Foreign Markets are a Necessary Profit Play for Today’s Income Investor