American depository receipts also know as (ADRs) were introduced to the market in 1927. ADRs are certificates serving the role of shares in foreign stocks that are issued by U.S.Banks. Bank issued ADRs can be bought and sold on the American market in the same way a regular stock can be acquired.
In the past a U.S. investor would need to open a brokerage account in the foreign region, research the stock that they would like to invest in and then send and convert their currency from the US dollar to the region’s currency so they could purchase the stock. The creation of the ADR alleviates several steps in investing in overseas markets, allowing U.S investors to easily and conveniently purchase shares in stocks where the U.S might not have a presence.
Today banks purchase bulk shares of a foreign company’s stock. Then, the bank bundles the shares into groups and assesses the value of the ADR. Once an affordable ADR value is determined they issue certificates on the market to be purchased just like normal shares on the market. One ADR may represent more or less than 1 share of the foreign company stock that trades on the home country stock exchange. For example, each ADR of BHP Billiton stock (BHP) represents 2 Australian BHP Billiton shares.
A considerable difference to consider with ADRs is how they are taxed on their dividends. Similar to U.S. stocks the dividends are taxable. Additionally, the dividends can be taxed by the ADRs country of origin. When adding ADRs to your portfolio be careful to avoid double taxation. Also keep in mind the local shares to ADR conversion ratio to determine the actual dividend per ADR if you know how much dividends were declared by the company (this communication will be in the terms of local shares).
Advantages of Purchasing American Depository Receipts (ADRs)
The following is a short list of some of the advantages to consider when purchasing ADRs
- ADR shares can be purchased on the market in the same manner as any other U.S. stock.
- ADRs can be bought and traded at the same hours as all other U.S. stocks.
- ADRs remove the need for foreign brokers.
- The Price of ADR shares are listed based on the U.S. Dollar
- Dividends for ADRs are paid out in U.S Dollars
Disadvantages of Purchasing American Depository Receipts (ADRs)
ADRs also have some drawbacks that should be considered when preparing to make a purchase.
- With ADRs there is a risk of exchange rate fluctuation. ADRs purchased with the U.S. Dollar still can be endanger of foreign currency drops.
- Only Foreign companies that make their shares available for ADRs can be purchased and not all foreign companies do.
- If you do invest in ADRs enough should be purchased to ensure diversity in your portfolio.
When analyzing a foreign company for investment through the ADR route, keep in mind that the accounting standards the company follows are very likely to be different than an American company. US follows the GAAP accounting standards whereas international companies are likely to adhere to the IFRS. Eventually the US is moving towards IFRS to harmonize with rest of the world but until this happens, it is important to realize the differences and adjust for them.