What are ADRs?
American Depository Receipts (ADRs) are stocks that are sold in the US market but represent ownership of the underlying shares in a foreign company. An ADR trades in US dollars and they allow investors to avoid the risk of transacting in a foreign currency. Before the introduction of American Depository Receipts, investors faced difficulties in buying shares of foreign companies and dealing with different currency values.
With American Depository Receipts, investors buy the stocks from US banks that purchase a bulk of shares from the foreign company through a custodian bank in the home country. The US bank then bundles the shares and reissues them on the New York Stock Exchange (NYSE) and NASDAQ. Investing in ADRs can give investors a more diversified portfolio and protect them from political, currency and inflationary risks.
Examples of ADRs
Diageo Plc ADR
Diageo is an alcoholic beverage company that is located in the United Kingdom. It’s been making efforts to expand its market in the United States. It trades on the NYSE under the symbol DEO. One Diageo ADR represents four ordinary DEO shares. Diageo’s dividend yield, as of 2018, is about 3%.
Teva Pharmaceutical ADR
Teva Pharmaceutical Industries is a Tel Aviv based manufacturer that specializes in generic drugs and specialty medicine. It trades on the NYSE under the symbol TEVA. Teva returns a dividend yield, as of 2018, of approximately 3%.
GlaxoSmithKline is a global pharmaceutical and healthcare company that is located in the United Kingdom. Established in 1999, it is now one of the market leaders in the healthcare industry. It trades on the NYSE under the code GSK. With a broad line of products, the outlook for GlaxoSmithKline looks promising. As of 2018, it pays a dividend yield of around 5%.
Infosys Limited is an India-based IT company that provides business consulting, information technology, and outsourcing services. It was ranked as the second-largest Indian IT company in 2017. It trades on the NYSE under the symbol INFY.
Siemens AG ADR
Siemens is an energy conglomerate company that is headquartered in Germany. It is the largest manufacturing company in Europe. Siemens specializes in electrification, automation, and digitization. Siemens delisted from the New York Stock Exchange in May 2014. It maintains its ADR program on a Level I basis and trades in the US on an over-the-counter basis. Two Siemens ADRs traded in US dollars equals one Siemens ordinary share. Siemens’ dividend yield, as of 2018, is about 3.4%.
Novartis AG ADR
Novartis is a Swiss multinational healthcare company that is headquartered in Basel, Switzerland. It is one of the largest pharmaceutical companies in the world in terms of sales and market capitalization. It is listed on the NYSE under the trading symbol NVS. The company owes much of its current success to M&A transactions.
Total S.A. ADR
Total S.A. is a France-based energy company, the world’s fourth-largest international oil and gas company. As an energy company, its stock prices are affected by the volatility of oil prices. The dividend yield, as of 2018, from Total ADRs is about 5.5%.
Determining the Price of ADRs
An American Depository Receipt represents a specified number of the regular stock shares of the foreign company. It may be expressed as a fraction of a share or multiple shares of the foreign company. For example, as noted above, one Diageo ADR represents four Diageo Plc ordinary shares. This can be expressed as a ratio, i.e., 4:1. Similarly, one ADR could represent half of an ordinary share of the foreign company.
Demand and Supply
Once an American Depository Receipt is listed on the NYSE, its price is determined by the forces of demand and supply. In most cases, the price of an ADR tends to follow the price of its parent shares trading in the country of origin. For example, if a Chinese company sells its ADR on the NYSE, the price will typically mirror the price of the company’s shares on the Shanghai Stock Exchange. If a major event occurs in the foreign country, e.g., a lawsuit loss or a ban on the company’s products, the effects of the event will be reflected in the price of the ADRs.
However, sometimes the prices of the ADR and the ordinary shares in the foreign company may vary somewhat, creating an arbitrage opportunity. Large investors may move to capitalize on the price discrepancy, which is usually only temporary. Arbitrage is common among institutional investors with access to more trading capital, trading specialists, intelligent software, and up-to-date news required to exploit such opportunities and earn profits from short-term price differences.
Risks of Investing in American Depository Receipts
Although American Depository Receipts trade in the domestic US markets in dollars, they possess some degree of risk that US investors should take into consideration. Here are some of the risks that face ADRs:
A foreign company may be profitable but its ADRs may lose value due to currency exchange rate fluctuations. When buying American Depository Receipts, consider the stability of the ADR’s home currency and its history against the US dollar. Currency fluctuations can result in significant losses for investors.
An ADR is affected by the home country’s political stability and sanctions. Before investing in an ADR, research the current situation in the issuer’s home country. If there are trading sanctions related to the country, the ADR prices will be affected.
Inflation risk is an extension of the currency risk. If the home country experiences high inflation, this will make its currency less valuable, and that will affect the ADR prices.
We hope you’ve enjoyed reading CFI’s explanation of ADRs. CFI is a global provider of the Financial Modeling & Valuation Analyst (FMVA)™ certification program for finance professionals. To learn more and expand your career, explore the additional relevant resources below: