International stocks, which represent stocks that trade outside of the United States, have significantly underperformed the U.S. stock market over the past decade. International stocks are sometimes called overseas stocks or foreign stocks.
For the period ending February 28, 2023, U.S. stocks, as measured by the MSCI USA Index returned 11.6% annualized compared to 4.8% for the MSCI World Ex U.S.A. Index, a measure of international stock performance.
International Stocks Dividend Yield
The dividend yield is the dividends per share divided by the price of a stock or stock index.
Over the past decade, the dividend yield for the MSCI World Ex-U.S.A. index has averaged 3.1% compared to 1.9% for U.S. stocks.
As of February 28, 2023, international stocks’ dividend yield is 3.1%, close to its long-term average of 3.0%.
International stocks are not overvalued when considering the dividend yield.
Currency Impact on International Stock Performance
International stock performance can be calculated in different currencies. The 4.9% annualized return for non-U.S. stocks over the past decade was quoted in U.S. dollars.
The 10-year performance of the MSCI World Ex U.S.A. Index in local currency was much higher at 7.4%.
Over the past decade, the U.S. dollar appreciated by 24% relative to the rest of the world.
A strengthening dollar reduces international stock performance when converted into U.S. dollars. This is because non-U.S. dividends and unrealized gains are worth less in dollar terms.
The strengthening dollar reduced international stock returns by about 2.7% per year over the past decade.
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International Stock Price-to-Earnings Ratio
Another reason international stocks trailed U.S. stocks over the past decade is U.S. stocks got more expensive while international stocks got cheaper.
As of February 28, 2023, the price-to-earnings ratio of international stocks is 14.4, as measured by the MSCI World ex U.S.A. index.
The long-term average P/E ratio for international stocks is 18.5. International stocks are undervalued as measured by the price-to-earnings ratio.
A decade ago, the P/E ratio for international stocks was 15.4. The decline in the price-to-earnings ratio for international stocks over the past decade lowered international equity returns by about 0.6% per year.
Meanwhile, the P/E ratio for U.S. stocks increased from 15.3 a decade ago to 20.8 today. The increase in U.S. stocks’ P/E ratio contributed about 3% per year to U.S. stocks’ performance for the ten years ending January 31, 2023.
International Stocks and U.S. Stocks Performance Attribution for 10-Year Period Ending February 28, 2023
Expected Returns for International Stocks
Expected returns for stocks are a function of the dividend yield, how much dividends increase as corporate earnings grow, and whether stocks get more expensive or cheaper.
Currency fluctuations also impact international stock returns if returns are converted to U.S. dollars.
If we assume a dividend yield of 3.1% for international stocks and earnings growth of 5.3%, which is how much earnings grew per year over the past decade, then international stocks could return 8.4% annualized over the next decade.
These expected returns are nominal before backing out inflation.
If the P/E ratio of international stocks rises, so it moves closer to its long-term average, then international stock returns could return over 10% annualized over the next decade.
Of course, international stock returns could be lower if earnings growth comes in less than 5.8% per year or if international stocks get cheaper than they are today.
International stock returns in U.S. dollars could be even higher if the U.S. dollar weakens over the next decade.
How to Invest in International Stocks
Individuals often ask, “Should I invest in international stocks?” The answer is yes because international stock expected returns over the next decade could be 9% or more.
This table provides some examples of international stock funds and ETFs.
|NON-U.S. EXCLUDING EMERGING MARKETS EQUITY
|Vanguard FTSE Developed Markets ETF
|Vanguard Developed Markets Fund
|Fidelity ZERO International Index Fund
|iShares Core MSCI EAFE ETF
|Schwab International Equity ETF
International stocks are not overvalued.
This is because their price-to-earnings ratio is lower than average and the dividend yields are close to average.
A combination of a cheaper-than-average price-to-earnings ratio and high dividend yield could allow international stocks to outperform U.S. stocks over the next decade, even though they lagged U.S. stocks over the past ten years.
David Stein is the founder of Money for the Rest of Us. Since 2014, he has produced and hosted the Money for the Rest of Us investing podcast. The podcast reaches tens of thousands of listeners per episode and has been nominated for ten Plutus Awards and won one. David also leads Money for the Rest of Us Plus, a premium investment education platform that provides professional-grade portfolio tools and training to over 1,000 individual investors. He is the author of Money for the Rest of Us: 10 Questions to Master Successful Investing, which was published by McGraw-Hill. Previously, David spent over a decade as an institutional investment advisor and portfolio manager. He was a managing partner at FEG Investment Advisors, a $15 billion investment advisory firm. At FEG, David served as Chief Investment Strategist and Chief Portfolio Strategist.