There are many ways to invest in foreign companies. International funds are the most common. But what about individual stocks? An ADR is an easy way to buy foreign stocks through your broker.
American Depositary Receipt or ADR is a type of security that represents shares of a foreign company. A U.S. depositary bank buys the foreign stock and issues ADRs in the U.S. market. Each ADR represents one or more shares (or a fractional share) of a foreign stock and trades at a price equal to the foreign stock.
This process makes it easier for investors to gain access to foreign companies like: BP, Toyota (TM), or Nokia (NOK). Which are all American Depositary Receipts traded on the NYSE.
Toyota, for example, has an ADR ratio of 1:2 (one ADR for two Toyota shares) and started trading on the NYSE in 1999. Before that, if you wanted to invest in Toyota, you had to open a trading account in Japan and convert your dollars to yen just to buy the shares. It’s not the easiest or most cost efficient way to invest internationally. That said, an ADR doesn’t eliminate the costs entirely.
The U.S. depositary banks don’t issue ADRs for free. The record keeping, compliance, and other services are passed on to investors as custody fees. Generally, the custody fees are taken out of dividend payments before being paid to the ADR holders. Or, if dividends aren’t paid, the fees are charged to your broker and passed down to you.
Like any investment, American Depositary Receipts, have its risks. The biggest being political, currency and regulatory risks:
- Currency Risk – While ADRs trade in dollars, the price will fluctuate based its foreign currency equivalent. Any big changes in the exchange rate will affect the price of the ADR.
- Political Risk – Unstable governments or nationalization should be a big concern when researching ADRs.
- Regulatory Risk – Not all ADRs have to fully comply with SEC reporting requirements. Which is a big red flag. Specifically, over the counter traded ADRs are the most risky. It’s best to check the SEC EDGAR database for information before investing.
The ease and convenience can outweigh the risks in many cases. Good research will eventually remove the bad apples. There are alternatives to limit your risks too. You can look into ADR indexes and ETFs. Or, focus on U.S. companies that do more business overseas. Either way, ADRs offer a convenient way to invest internationally.