20 Investments: American Depository Receipt (ADR)
What Is It?
Introduced to the financial markets in 1927, an American Depository Receipt (ADR) is a stock that trades in the United States but represents a specified number of shares in a foreign corporation. ADRs are bought and sold on U.S. stock markets just like regular stocks and are issued/sponsored in the U.S. by a bank or brokerage.
ADRs were introduced in response to the difficulty of buying shares from other countries which trade at different prices and currency values. U.S. banks simply purchase a large lot of shares from a foreign company, bundle the shares into groups and reissue them on either the NYSE, AMEX or Nasdaq. The depository bank sets the ratio of U.S. ADRs per home country share. This ratio can be anything less than or greater than 1. For example, a ratio of 4:1 means that one ADR share represents four shares in the foreign company.
The majority of ADRs range in price from $10 to $100 per share. If the shares are worth considerably less in the home country, then each ADR will represent several real shares. Foreign entities generally like ADRs because it gives them U.S. exposure, which allows them to tap into the rich North American equity markets. In return, the foreign company must provide detailed financial information to the sponsor bank.
Objectives and Risks
The main objective of ADRs is to save individual investors money by reducing administration costs and avoiding duty on each transaction. For individuals, ADRs are an excellent way to buy shares in a foreign company and capitalize on growth potential outside North America. ADRs offer a good opportunity for capital appreciation as well as income if the company pays dividends.
Analyzing foreign companies involves more than just looking at the fundamentals. There are some different risks to consider such as the following:
Political Risk - Is the government in the home country of the ADR stable?
Exchange Rate Risk - Is the currency of the home country stable? ADRs track the shares in the home country; therefore, if its currency is devalued, it trickles down to your ADR and can result in a loss.
Inflationary Risk - This is an extension of the exchange rate risk. Inflation is a big blow to business, and the currency of a country with high inflation becomes less and less valuable each day.
How to Buy or Sell It
ADRs are bought in exactly the same way as common stock. Whether you use a full service or discount brokerage doesn't matter. There is no minimum investment for most ADRs; however, as with any investment, many brokerages require clients to have at least $500 to open an account.
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