European Dividend Stocks: What You Need to Know

For all the talk of dividend investing in recent years, it�s easy to lose sight of the fact that the average U.S. stock, as measured by the S&P 500, still yields a paltry 1.9%.

Even the Vanguard Dividend Appreciation ETF (NYSE:VIG), a core long-term holding in my ETF portfolio — barely yields 2%, and this is a dividend-focused product.

In a world where the 10-year Treasury note yields an almost laughable 1.5%, the dividends on U.S. stocks might seem downright rich in comparison.� But for an investor looking to fund their retirement through portfolio income, they still don�t pay the bills.

Not surprisingly, many investors have gravitated to higher-yielding European stocks.� The dividend yield on large-cap European stocks is more than double that of their U.S. counterparts; as a case in point, the Vanguard MSCI Europe ETF (NYSE:VGK) yields 4.3%, compared to the 1.9% offered by the SPDR S&P 500 ETF (NYSE:SPY).

The PowerShares International Dividend Achievers ETF (NYSE:PID), which like VIG, focuses on dividend growth rather than high current yield, also pays out significantly more than its U.S. counterpart, at 3.1% vs. 2.0%.

Still, those higher yields have offered little protection to investors who have seen their �safe� dividend paying stocks lose 20% of their value in a matter of weeks.� �I see a lot of value in European current prices, and I believe the ongoing sovereign debt crisis has created opportunities for those of us willing to take the risk of a little short-term volatility.

But given that the months ahead promise to be a rocky road, it�s important that investors understand a few things about European dividend stocks.

Here are a handful of points to keep in mind.

1) When looking at the dividend history, remember to take into account the effects of currency moves.

As a case in point, consider the Anglo-Dutch consumer products giant Unilever (NYSE:UL).� Unilever has raised its dividend for over 25 consecutive years.� But if you look at the company�s dividend history on, say, Yahoo (NASDAQ:YHOO) Finance, you�ll see that the dividend paid by the U.S.-traded ADR appears to shrink in some years.� This is due to changes in currency exchange rates.� So, when doing your research, look for the dividend history in the reporting currency and take the posted dividend history of ADRs with a grain of salt.

2) European firms tend to make two payments per year.

For U.S. investors accustomed to regular quarterly payouts, the European tradition can be confusing and send conflicting signals.� There is generally a larger �final� dividend declared and paid after the fiscal year has finished and a smaller �interim� dividend roughly six months later.� Again, using Unilever as an example, you can see that this was the company�s policy prior to 2010. (Starting in 2010, Unilever adopted a policy more in line with American norms of paying a regular quarterly dividend; see the company�s statement for more info.)

3) Rather than keep the dollar amount of the dividend stable, European firms have historically sought to maintain a stable payout ratio.

This means that the cash payout to investors can vary wildly based on the company�s performance in any given year.� While this makes sense from the company�s perspective and allows for more financial flexibility, it can be frustrating for investors who depend on the dividend to meet their current income needs.� As capital markets become more global and investors more vocal, European companies are slowly adopting the �practice of paying more regular dividends.

One final point to consider when investing in Europe is the maturity of the markets.�Europe is a developed continent with an aging population.� With little need to invest for� growth in their home markets, European companies are, by and large, mature cash cows that throw off a lot of cash.

In The Future for Investors, Jeremy Siegel pointed out that slow-growth companies (or even negative growth) companies can make fantastic investments, and he used tobacco giant Altria (NYSE:MO) as an example.� By Professor Siegel�s calculations, Altria was the most profitable investment of the past century, despite the fact that tobacco has been a dying business since at least the 1970s.��� With no need to invest in a non-existent future and being restricted from advertising, Altria had little else to do with its cash than to pay dividends.

Though I would stop short of comparing the entire European stock market to Big Tobacco, the lessons are much the same.� A slow-growth, high-dividend portfolio can produce spectacular returns over time.

I�ve recommended PID as a �fishing pond� for solid European dividend stocks, and I would reiterate that recommendation today.� Consider buying the ETF or, if you�re up for the challenge of researching individual stocks, use the ETF�s underlying holdings as a screened list of high-quality dividend payers from which to choose.

Disclosures: Sizemore Capital is long MO, PID, UL, and VIG