American Depository Receipt Explained

ADR or an American Depository Receipt is a certificate issued by American banks that represent shares of foreign companies. Usually, one ADR is the equivalent of one share of the company’s stock. These foreign ADRs then trade as normal stocks on the US stock market. Anyone who has access to the US markets can invest in these ADRs. 

How Does an American Depository Receipt Work?

American Depository Receipt

ADRs are most commonly used for companies based out of China that trade on the US  markets.

But an American Depository Receipt can apply to any foreign company and is settled in US dollars and cleared through the US market settlement system.

In essence, these are foreign companies trading on the US markets in US dollars for US investors.

Currently, there are over 2,000 ADRs from 70 different countries around the world. How does this work for the bank? ADRs are generally offered by banks with international locations.

This way, they can purchase shares of the company in its home market, hold them, and then offer ADRs to US investors. Even though ADR stocks are listed on the US exchanges like the NASDAQ, they are sold on the OTC markets. 

Sponsored ADRs vs Unsponsored ADRs

Not every American Depository Receipt is equal though. A sponsored ADR is the more common way that these stocks are handled by banks. In this situation, a bank will issue the sponsored ADR on behalf of the foreign company. This means the foreign company retains control over the asset while the bank handles the transactions with investors in the US. 

Sponsored ADRs also need to comply with the SEC regulations as well as American accounting procedures. This last point is one that is currently under fire by foreign countries like China, but more on this a little later. 

Unsponsored ADRs are much less common. This is because these ADRs are mostly uninvolved and not related to the foreign company at all. There is a chance that multiple different banks will offer different unsponsored ADRs for the same company.  This can obviously be confusing for American investors and can even affect the dividend amounts paid out. Unsponsored ADRs trade exclusively over the counter, while sponsored ADRs are listed on the major exchanges. 

How Do I Buy an American Depository Receipt Stock?

American Depository Receipt

For the investor, buying shares of American Depository Receipt stocks is the same process as buying shares of a US-based company.

The stock is listed directly on the US markets so as long as your brokerage has access, it’s like buying any other stock.

If your brokerage also offers stocks listed on foreign markets, make sure you know which you are buying.

The ADR will likely be listed on the New York Stock Exchange or NASDAQ. They also generally have the acronym ADR directly in the name of the security. 

Benefits of Investing In an American Depository Receipt

As with most things in the financial world, there are obvious benefits to being able to invest in ADRs. Investing in US-based companies and the S&P 500 has long been a winning strategy. B

ut that does not mean it’s not worth investing in international companies as well. A well-diversified portfolio always has room for well-performing, profitable companies. Here are some benefits to adding American Depository Receipt stocks to your portfolio. 

International Exposure With an American Depository Receipt

American Depository Receipt

The US has the best track record of returns from its stock market over the past few decades.

This brought American Depository Receipt stocks in.

But most American brokerages do not have access to international stock exchanges.

There are plenty of companies around the world that have also brought investors high returns over the years.

Until last year, China was an incredible market for growth, especially amongst its big tech firms. Before the regulatory crackdowns, major Chinese tech companies were on par with the mega-cap tech companies in the US. 

No Foreign Currency Fees

Depending on your investing brokerage, you will likely be charged foreign currency fees when buying foreign stocks. Not only is this a hassle for you, but it is incurring unnecessary fees that take away from your profits.

Luckily, when you invest in American Depository Receipt stocks on the US stock market, you are buying and selling in US dollars. That means no foreign currency fees and no lost capital on any potential foreign exchange transactions either. 

No Foreign Tax Liabilities

When trading stocks on foreign markets, your capital gains are also subject to that country’s taxation laws. Similar to currency, any capital gains you make trading American Depository Receipt stocks are subject to American tax laws. It doesn’t mean you’ll be taxed less in the US, but when it comes to filing income taxes it just makes things simpler. 

Foreign Companies Get US Exposure

American Depository Receipt stocks are not just beneficial for US investors as foreign companies benefit too. Sure, there is wealth in every country in the world, but stock markets pale in comparison to the US markets.

By getting exposure to US investors, foreign companies can likely raise more capital than in their home market. Of course, this leads to the usual ability to expand the business and grow operations. 

The Top ADR Stocks to Invest In

Money

You might be surprised at how many of the top stocks on the US markets are ADRs.

Some notable things about these American Depository Receipt stocks include not being included in the S&P 500.

Of course, the benchmark index is composed of 500 of the top American companies. Many of these ADR companies do have US operations, but they are headquartered internationally. 

Finally, ADR stocks tend to trade at essentially the same value as they do on their home exchanges. This is to eliminate any opportunity for arbitrage between markets. Because of this, markets that open earlier like in Asia do often impact US trading hours later in the day.

Taiwan Semiconductor Manufacturing Company (NYSE: TSM)

Our first American Depository Receipt stock is $TSM. Due to the recent weakness in tech companies in Mainland China, Taiwan Semiconductor has thrived. In fact, earlier this year it became Asia’s most valuable company.

That is saying a lot with companies like Tencent and Softbank on that list. But the global chip shortage that hit manufacturing across most tech industries has proven just how important this company is. 

While companies like NVIDIA and AMD design chips, they don’t actually make them. It is a common misconception for the chip industry. Instead, fabrication companies like TSMC do most of the manual labor. TSMC has a market cap of just under $600 billion, pays a 1.57% dividend yield, and belongs in any diversified stock portfolio. 

Alibaba (NYSE: BABA) 

I get it, investors have been avoiding Alibaba like the plague over the past year. This does not make it any less of a dominant company in the world’s largest consumer market. Ongoing regulatory crackdowns have really hit Alibaba’s stock. It has been trading at multi-year lows and has lost 50% of its market cap during this time. 

Despite this, Alibaba’s Taobao and Tmall eCommerce sites are still booming across Asia. Its AliPay super app is one of the most commonly used digital payment systems on the continent as well.

Furthermore, Alibaba has a rapidly growing cloud computing segment that is seeing the company follow in Amazon’s footsteps. Noted investor Charlie Munger recently doubled down on his investment in Alibaba as well. Sometimes when others are fearful, it’s time to think about being greedy. 

Nio (NYSE: NIO)

China is also home to the largest automotive market in the world. The Chinese government has made it its mission to build the best EV market in the world as well. There are several major players in China including XPeng and Li Auto both of which are ADRs as well. But Nio has incorporated some unique technology into its vehicles that have set it apart from the competition. 

Nio is most famous for its battery swap technology which has been revolutionary in the EV market. Drivers can head to Nio battery swap stations, and rather than wait in line to use a charger, they can simply swap out their low battery for a full one. The company has also recently expanded to Europe and plans to hit 25 new markets by 2025, including the US. 

BioNTech (NASDAQ: BNTX)

BioNTech is a biotechnology company based out of Germany while trading on the NASDAQ exchange. You might have heard of this company as the co-creator of the widely used COVID-19 vaccine that it made with Pfizer. BioNTech specializes in mRNA-based cancer treatments as well as vaccines for rare diseases. 

Does An American Depository Receipt Stock Make A Good Investment

The four companies listed above are solid and have mostly proven to be good investments over time. But for every TSMC, there are dozens of companies without a strong business to back them up.

Research ADR stocks you want to invest in and know that those companies do not adhere to American business laws. This is where the controversy over different accounting regulations in China has reared its head.

Companies like Luckin Coffee and Kandi Technologies have had many US investors buy their ADR shares when they were carrying out fraudulent businesses overseas. The right ADR stocks can be solid additions to your portfolio, but they will likely require an extra step of research before hitting the buy button. 

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