Three Main Uses Capital Appreciation Income Diversification

What is it?
Introduced to the financial markets in 1927, an American Depository Receipt (ADR) is a stock which trades in the United States but represents a specified number of shares in a foreign corporation. ADRs are bought and sold on American stock markets just like regular stocks, and are issued/sponsored in the U.S. by a bank or brokerage.

ADRs were introduced because of the difficulty in buying shares from other countries which trade at different prices and currency values. U.S. banks simply purchase a large lot of shares from a foreign company, bundle the shares into groups and reissue them on either the NYSE, AMEX, or Nasdaq. The depository bank sets the ratio of U.S. ADRs per home country share. This ratio can be anything less than or greater than 1. For example, a ratio of 4:1 means that 1 each ADR share represents 4 shares in the foreign company.

The majority of ADRs range in price between $10 and $100 per share. If in the home country the shares are worth considerably less then each ADR would represent several real shares. Foreign entities generally like ADRs because of the U.S. exposure that allows them to tap into the rich North American equity markets. In return the foreign company must provide detailed financial information to the sponsor bank.

Objectives and Risks:
The main objective of ADRs is to save individual investors money by reducing administration costs and avoiding duty on each transaction. For individuals, ADRs are an excellent way to buy shares in a foreign company and capitalize on growth potential outside North America. ADRs offer a good opportunity for capital appreciation as well as income if the company pays dividends.

Analyzing foreign companies involves more than just looking at the fundamentals as there are some different risks to consider such as:

Political Risk - Is the government in the home country of the ADR stable?

Exchange Rate Risk - Is the currency of the home country stable? ADRs track the shares in the home country, therefore if their currency is devalued it trickles down to your ADR and can result be a loss.

Inflationary Risk - This is an extension of the exchange rate risk. Inflation is a big blow to business, the currency of a country with high inflation becomes less and less valuable each day.

How to Buy or Sell it:
ADRs are bought the exact same way as with common stock . Whether you use a full service or discount brokerage doesn't matter. There is no minimum investment for most ADRs, but as with any investment many brokerages require clients to have at least $500 to open an account.

Strengths:

ADRs allow you to invest in companies outside North America with greater ease. By investing in different countries you have the potential to capitalize on "up and coming" economies.

Weaknesses:

there is more risk with an ADR such as political factors, exchange rates, etc. a lack of standards in financial disclosure and different languages can make it difficult to research foreign companies.

Next: 2. Annuity