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BI > MAY 2003Portable Document Format (help)Printer Friendly Version The World of ADRsForeign Stocks on U.S. Exchangesby Adam Ritt Investors interested in globalizing their portfolio have several options, including mutual funds that invest in foreign stocks and stocks of U.S. companies that derive a large portion of their income overseas. The more adventurous investor who wants a more direct route to Europe, Asia and the rest of the world can buy stocks directly through foreign exchanges. Investors who are more risk-averse can study American Depositary Receipts, or ADRs. ADRs represent shares of a foreign-based company; technically, they're not the actual shares of stock. But they entitle the shareholder to all the stock's dividends and capital gains. ADRs, which have been around since 1927, also are commonly referred to as American Depositary Shares. You could buy foreign stocks on an overseas exchange, but that would be relatively cumbersome. You would have to contend with issues such as buying with a foreign currency and learning the market practices of the exchange on which the stock is traded. "I hold 14 stocks on the Singapore Stock Exchange and only two stocks on the Indonesian Stock Exchange," says Ivan Hodiny, an NAIC member who's based in Indonesia. "The Indonesian Stock Exchange is a nightmare; that's why I stopped buying there. A company can disappear or be suspended indefinitely from the stock exchange list overnight (literally) because of bankruptcy or unethical doings. U.S. and Singapore exchanges are far more regulated, and I felt a lot safer buying stocks on these two exchanges." ADRs are bought on U.S. exchanges in U.S. currency, and you receive dividends in U.S. currency. ADRs are treated the same way as other U.S. securities in terms of clearance, settlement, transfer and ownership, the Bank of New York says. They can represent both common and preferred stock. The ADR's price corresponds to the foreign stock's price in the company's home country. There are more than 2,000 Depositary Receipt programs for companies from more than 70 countries, says the Bank of New York, which issues Depositary Receipts for more than 1,400 programs. The ADR is just one type of Depositary Receipt. Others include Rule 144A Depositary Receipts, which are privately placed and resold only to qualified institutional buyers, and Global Depositary Receipts, which are generally available in one or more markets outside the foreign firm's home country. ADRs also are classified as Level I, II or III. Each level has its own regulations. See below for online resources of information about the various types of ADRs and make sure you understand the regulations governing the ADR you're studying. Among the benefits for overseas firms, Depositary Receipt programs can improve their visibility outside their domestic market and make it easier for employees of their U.S. units to invest in the parent company. In mid-March, JPMorgan's ADR research site reported that the issuers with the most widely held ADR programs were Royal Dutch Petroleum Company; BP p.l.c.; Nokia Corporation; Telefonos de Mexico, S.A.; Unilever N.V.; GlaxoSmithKline plc; KT Corporation; Vodafone Group Plc; TotalFina SA; and Teva Pharmaceuticals Industries Ltd. ADRs are issued by a U.S. depositary bank, and the shares they represent are held in a bank in the company's home country. It's important to note that one ADR doesn't necessarily equal one share of the company's stock. "The depositary bank sets the ratio of U.S. ADRs per home country share," say Art Kamlet and George Regnery at The Investment FAQ. "This ratio can be anywhere and can be less than or greater than one. Basically, it is an attempt to get the ADR within a price that Americans are comfortable with." Therein lies a possible benefit of ADRs: A foreign stock that investors might not be interested in because it trades at high price levels in the company's home country might trade at a more reasonable price level in the United States. For example, if shares in a British firm traded at the equivalent of $500 on the London Stock Exchange, the ADR might have a ratio of, say, 10:1, meaning that investors would pay $50 for the ADR; of course, each ADR would represent only a tenth of a share. Why Go Global? People typically recommend buying foreign stocks because they help diversify your portfolio by geography and reduce your total risk. The idea is that business cycles around the globe fluctuate at different times; if the United States experiences a downturn, some other countries or regions could be in an upturn. As you can see in Figure 1 below (from Jeremy Siegel's Stocks for the Long Run), total dollar returns in major equity markets have varied widely in some periods; note the steep ascent in Japan and subsequent fall, for example. Interestingly, the total returns from 1970 to 2001 among the four markets examined were almost identical. Total Dollar Returns in Major Markets, 1970 - 2001
But in Stocks for the Long Run (McGraw-Hill, 2002), Siegel says that over the past several years, the correlation among countries' economies seems to be increasing. In other words, business cycles among various countries increasingly are going up and down at the same time. This makes sense, given increasing globalization. Siegel still argues that investors should own foreign stocks, partly because he isn't certain this pattern will continue. "Sticking only to U.S. equities is a risky strategy for the long-term investor," he says. "The most important change influencing international investing . . . is that one can no longer judge the desirability of stocks by noting the country in which the company is headquartered," Siegel says. "The globalization of the world economy means that the strength of management, product line and marketing are far more important factors than where a firm is domiciled." Siegel's research indicates that major industry sectors are becoming less and less correlated. This means "investors should look to diversify among the top worldwide firms rather than target specific country allocations," he says. You probably can globalize your portfolio sufficiently by buying some stocks of U.S. companies that have a substantial percentage of overseas business. For example, more than half of Caterpillar's $20 billion in annual sales is overseas, Value Line reports. This diversity is helping the equipment manufacturer withstand difficult times in its domestic market. "In the current situation, sales to the North American on-highway truck, power generation, general construction and coal-mining sectors, as a whole, continue to be weak," Value Line says. "Fortunately for CAT, stronger demand in EAME (Europe, Africa and the Middle East) and the Pacific Rim has largely offset the difficulties at home." So the argument that you need to buy foreign stocks isn't cut and dry. But even if you don't believe you need foreign stocks for diversification, you should consider them simply to broaden your universe of potential investments. At the end of 2002, U.S. companies accounted for 52 percent of the world's $20.2 trillion in stock market capitalization (see chart, Performance Perspectives), Ibbotson Associates says in its latest annual report. If you're not considering foreign stocks, you're closing yourself off to almost half the world. "If an investor were to limit the scope of his or her investments strictly to the United States, many countries that are home to world-class industries would be excluded," Ibbotson says. "Switzerland has a major presence in the pharmaceutical industry, Germany in the automotive industry and Japan in the consumer electronics industry. Globalization has helped to increase brand awareness with investors across the world." A quick look at just the first 50 names on Fortune's Global 500 for 2002 below will reveal numerous foreign companies. Many of them are familiar -- BP, Royal Dutch/Shell Group, Toyota Motor, Mitsubishi and Deutsche Bank, for example -- and some are perhaps not so familiar -- Total Fina Elf, an integrated oil firm based in France; E.ON, a German energy group; and Assicurazioni Generali, an insurance company based in Italy.
FORTUNE GLOBAL 500 IN 2002
Just as Caterpillar relies on international business, many overseas firms consider the United States a critical market. Toyota Motor Corp. is one such company. In 2001 overseas business accounted for 3.55 million, or two-thirds, of the company's total sales of 5.27 million vehicles. The United States is by far Toyota's most important overseas market. In fact, in 2001 U.S. sales of 1.74 million vehicles surpassed the Japanese automaker's domestic sales of 1.72 million. Australia was Toyota's No. 2 overseas market in that year, accounting for sales of 144,000 vehicles, followed by Canada, the United Kingdom and Italy. Toyota also has an ADR available on the New York Stock Exchange under the ticker symbol TM. The company's ADR ratio is 1:2; each ADR represents two shares of Toyota's common stock. Holders of Toyota ADRs may participate in a dividend reinvestment plan as well. Toyota is also listed on the Tokyo Stock Exchange and London Stock Exchange. More Legwork When studying an ADR, you'll probably need to do more legwork and have more patience than you would for a U.S. company's stock. Value Line and Standard & Poor's have data for ADRs, but updated numbers from foreign firms often come later than they would for their U.S. counterparts. Foreign companies with ADR programs are required to follow the reporting requirements of whatever exchange they're listed on. But they're not required to file many of the reports with the Securities and Exchange Commission you typically might find useful in your stock study, such as 10-Ks and 10-Qs. For ADRs traded on U.S. exchanges, "Foreign companies file annual reports with the SEC as well as other information available in their home countries," the commission says. "Annual reports contain financial statements audited by independent accountants using U.S. audit standards. The financial statements either will be prepared using U.S. accounting principles or will show what the key results would have been under U.S. accounting principles. This makes it easier to compare a company's financial position to similar U.S. companies." Accounting practices and the financial information public companies need to provide often varies from U.S. standards; that doesn't mean foreign companies therefore are less trustworthy, however. Financial information also might not be stated in U.S. currency, although many multinational companies with ADR programs offer annual reports in English that restate results in U.S. dollars. If you have questions, try contacting the company's investor relations department. Some companies have U.S.-based IR personnel. Foreign firms often use different terminology as well. "You'll find accounts receivable becomes debtors, inventory becomes stock on hand or just stock, accounts payable becomes creditors, and so on," an NAIC member based in Switzerland says. "Cash flow statements are very different, so you'll need to do some work if you want to calculate something like free cash flow." If you're using Online Premium Services to complete your Stock Selection Guide on an ADR, you might discover that there isn't data for every quarter. Nokia, for example, reported only full year-end results in fiscal 2001; many of the quarterly numbers are missing for that year. The Finnish company also has gaps in 1997, 1998 and 2000 quarterly data. Until recently Toyota Motor Corp. reported financial results twice a year. If you're using a Value Line report to complete an SSG for an ADR, substitute "per ADR" whenever you see "per share," says Brian Lewis, an associate director of the National Investors Association Board. "In that case, if you just stick to the Value Line form itself apart from current price, there's no problem." The possibility that fluctuating currency exchange rates will hurt your investment's value is among the risks of investing in a foreign firm. ADRs are U.S. dollar-denominated securities and pay dividends in U.S. dollars, but they don't eliminate the currency risk of investing in a foreign company, JPMorgan's ADR site says. Let's consider dividends: Foreign companies issue them in the currency of their local market. You receive dividends after the foreign currency is converted into U.S. dollars. "During a period when the foreign currency is strong compared to the U.S. dollar [that is, when the currency's value increases compared with the dollar], this strength increases your returns because your foreign earnings translate into more dollars," the SEC explains. "If the foreign currency weakens compared to the U.S. dollar, this weakness reduces your returns because your earnings translate into fewer dollars." For example, say the exchange rate on a given date is 4 euros for every U.S. dollar; in other words, 1 euro is worth 25 cents. If a company issues a dividend of 10 euros, you'd receive $2.50. But then the exchange rate fluctuates to 2 euros for every dollar. This means that a euro now is worth 50 cents -- in other words, the euro is stronger relative to the U.S. dollar. That dividend of 10 euros, when converted into U.S. currency, now becomes $5. You might read about a strategy to offset currency risk called hedging. This involves purchasing another investment, perhaps in the futures or options market, that an investor expects to increase in value if the value of a particular investment goes down. But hedging is extremely complex and risky. (Editor's note: As an aside, because of the explosive use of hedging and hedge-fund offerings, members of BI's Editorial Advisory and Securities Review Committee cautioned that hedge funds could be the next investment crisis.) Long-term investors probably don't need to worry so much about currency fluctuations anyway. Besides, the purpose of buying an ADR is to make international investing easier, not harder. LARGEST COMPANIES FOR SELECTED INDUSTRIES Banks: Commercial and Savings
Beverages
Electronics, Electrical Equipment
Food Consumer Products
Industrial & Farm Equipment
Network and Other Communications Equipment
Pharmaceuticals
Telecommunications
For More Information -- Online Resources Here are four excellent Web sites for studying ADRs that are dedicated to these investment vehicles: These extensive sites allow you to research individual ADRs, study performance tables and graphs, and read news articles concerning foreign companies. The Bank of New York site allows you to search for ADRs by industry, country or region and links to pages that provide ADR education; just click DR Education in the menu on the left-hand side. The Citibank site proved especially useful for studying individual ADRs. Its company information includes financial ratios, annual income statements, annual balance sheets and annual cash flows. Readers who wish to delve into the mechanics of ADRs should first read a lucid summary of them that includes discussions of tax and shareholder voting issues by Art Kamlet and George Regnery at The Investment FAQ. Another worthwhile background document, albeit a much more technical one, is at law firm White & Case's Web site. To research foreign companies, you might try Fortune magazine's Global 500, published in its July 22, 2002. Companies on the list are arranged in numerical order, alphabetically, by industry, by region and by performance parameters such as highest returns on assets. Clicking on the company name leads to basic information on the firm. You can also access a company capsule by Hoover's. There's some subscriber-only content as well. Fortune's site also provides access to its Global Most Admired list, although there's little free content -- just the 50 most admired and a few related articles. The SEC offers an online brochure on international investing that's well-written and easy to understand. The brochure covers reasons for international investing, risks, costs, different ways to invest internationally and what you should do after you decide to do so. Adam Ritt, Editor, BetterInvesting Magazine. |
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