What is ADR?
In short
A certificate issued by a US depositary bank representing shares of a foreign company, traded in dollars on a US exchange.
Also known as: American depositary receipt
An ADR (American Depositary Receipt) is a certificate issued by a US depositary bank that represents shares of a foreign company. The bank buys and holds the company's shares on its home exchange and issues ADRs against them, which trade in dollars on a US exchange. As a result, you can invest in a European or Asian company through a US broker, just like an ordinary stock.
The ADR ratio
One ADR is not always one foreign share. The ADR ratio says how many underlying shares one ADR represents (for example, 1 ADR = 5 shares or 1 ADR = 0.5 shares). The ADR's fair price:
ADR price ≈ Underlying share price (local currency) × Exchange rate × ADR ratio
Arbitrage keeps the ADR price close to this figure.
What to watch
- Currency risk. Even if the shares do not move in their home market, a change in the exchange rate changes the ADR's dollar price.
- Depositary fee. The bank charges a small yearly fee per ADR (usually a few cents), often taken out of dividends.
- Tax. The company's home country may withhold tax on dividends.
- Trading hours. The home market trades at different hours from the US, so an ADR can open with a gap reflecting overnight moves.
- Shariah screening. Financial statements are in the local currency; when calculating ratios, the currency and the ADR ratio must not be mixed up — see the methodology.
Example
A fictional British company:
- Share price in London: £4.00.
- Exchange rate: £1 = $1.25.
- ADR ratio: 1 ADR = 5 shares.
The ADR's fair price: £4.00 × 1.25 × 5 = $25.00. If the ADR trades at $25.10, that is a $0.10, or 0.4%, premium (0.10 ÷ 25).
Now the shares stay flat in London, but the pound falls to $1.20: £4.00 × 1.20 × 5 = $24.00. The 200 ADRs you own lose 200 × ($25 − $24) = $200 in value — from the currency alone.
With a depositary fee of, say, $0.02: 200 × $0.02 = $4 a year.
Mistakes and tips
Do not compare an ADR's price directly with the foreign share price — factor in the ADR ratio and exchange rate first.
Remember currency risk: if the dollar strengthens, the ADR can fall even when the company is doing well.
Expect depositary fees and foreign withholding tax to be deducted from dividends.
Frequently asked questions
- If I buy an ADR, do I own the company's shares?
- You own a certificate representing a claim on underlying shares held by the bank. Economically it is close to owning the stock, but rights such as voting go through the bank and can be limited.
- How is an ADR different from a regular US stock?
- An ADR is backed by a foreign company's shares, so it adds currency risk, the ADR ratio, depositary fees and foreign withholding tax.
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