A convenient way to trade foreign stocks

American depositary receipts provide individual investors with a way to invest overseas using U.S. exchanges and U.S. dollars.

Adam Zoll 22 December, 2014 | 1:00PM

Question: I occasionally see the letters "ADR" after the name of a stock. What do they stand for?

Answer: ADR stands for American depositary receipt and refers to a vehicle for trading non-U.S. stocks on U.S. exchanges. An ADR is like a stock certificate good for a specified number of shares in an overseas company, and the price of an ADR is linked to the price of the company's stock in its home country. ADRs are denominated in U.S. dollars, with dividends paid in U.S. dollars, as well. And like U.S. stocks, they are subject to the regulations of the Securities and Exchange Commission.

Special structure

An ADR is operated by what is called a depositary bank, which basically serves as a custodian for the foreign shares while issuing equivalent shares for trading on U.S. exchanges (called American depositary shares). The depositary bank also converts dividends and other cash payments from the foreign stock's native currency to U.S. dollars and distributes them. It's important to remember that even though they are denominated in U.S. dollars, ADRs are not immune to currency fluctuations. Because shares and distributions from the underlying stock originate in the foreign company's native currency, any movements in that currency could affect the ADR's share price and the value of distributions.

The main appeal of ADRs for North American investors is convenience. They allow for ownership of shares in foreign companies without the worry of complications such as trading on foreign exchanges or converting into currencies other than the U.S. dollar. Tax treatment also is similar to that of U.S.-based stocks except that dividend payments might be subject to a withholding tax from the stock's home country.

There are costs associated with this convenience, however. The depositary bank often charges a fee for administration of the ADR and this is usually subtracted from dividends to be paid out to shareholders. For this reason, ADR dividends are sometimes referred to as "net dividends," meaning what shareholders receive once the depositary bank's fee is deducted. If the foreign company underlying the ADR doesn't pay a periodic dividend, shareholders might be charged a fee directly.

ADRs are not the only way for North American individual investors to buy and sell shares in foreign companies. Some Canadian and U.S. brokerages offer direct trading of foreign stocks on foreign exchanges in foreign currencies. These accounts have the added advantage of providing access to the many foreign companies that are not available for trade as ADRs. However, brokerages may charge more for foreign exchange trades than they do for trades on Canadian or U.S. exchanges, as well as add on fees for currency conversions and any local trading charges that apply.

A look at the ADR universe

The first ADR was introduced in 1927 as a way to make shares of the British department store Selfridges available to U.S. investors. Today there are more than 350 ADRs listed on the New York Stock Exchange, NYSE Amex or NASDAQ, with hundreds more non-listed ADRs available through the over-the-counter market. Those traded on U.S. exchanges include such well-known names as  Royal Dutch Shell RDS.A,  BP PLC BP,  Toyota Motor TM,  GlaxoSmithKline GSK and  Vodafone Group VOD. The total value of all ADR shares listed on U.S. exchanges was about US$5.4 trillion as of the end of November, with an average market cap of US$15.3 billion per company.

Nearly one third of assets invested in exchange-listed ADRs are held in shares of British companies, followed by Japan (11%), Switzerland (8%), China (6%), France (6%) and Brazil (5%). Top industries represented by exchange-listed ADRs include financials (24% of all assets), health care (15%), consumer goods (14%), oil and gas (13%), technology (10%), telecommunications (9%) and basic materials (6%).

There also are ADR indexes and exchange-traded funds that track them, such as the BLDRS Europe 100 ADR Index ADRU, which tracks an index of 100 Europe-based ADRs, and BLDRS Emerging Markets 50 ADR Index ADRE, which tracks an index of 50 ADRs from emerging markets.

Aside from individual investors, mutual funds also may invest in ADRs if doing so proves cheaper than buying a foreign company's shares on an overseas market. In most cases, a company's ADR will track closely with its overseas stock price, but not always, which can create arbitrage opportunities for traders looking to profit from the price difference.

Have a personal finance question you'd like answered? Send it to AskTheExpert@morningstar.com.

Securities Mentioned in Article

Security NamePriceChange (%)Morningstar Rating
BP PLC ADR38.85 USD0.03
GlaxoSmithKline PLC ADR47.85 USD1.46
Royal Dutch Shell PLC ADR Class A58.52 USD-0.43
Toyota Motor Corp ADR139.81 USD-0.21
Vodafone Group PLC ADR19.98 USD-1.58

About Author

Adam Zoll

Adam Zoll  Adam Zoll is an assistant site editor with Morningstar.com