Understanding US Stock ADRs in One Article: From Basic Concepts to Investment Overview

What is ADR? A Quick One-Sentence Explanation

What is an ADR (American Depositary Receipt)? Simply put, it is a “stock deposit certificate” issued by foreign companies in the U.S. market. When companies like TSMC, BYD, Tencent want to raise funds in the U.S. securities market, they choose to issue ADRs, allowing global investors to buy these companies’ stocks just like trading regular U.S. stocks.

The process works as follows: foreign companies deposit their shares with a U.S. depositary bank, which then issues equivalent ADR certificates. As a result, investors do not need to open foreign securities accounts or exchange currencies; they can trade directly on the NYSE, NASDAQ, or OTC markets.

Why Buy ADR? The Win-Win Logic for Companies and Investors

For companies, issuing ADRs is much simpler than directly listing in the U.S. Many foreign companies are already listed in their home countries and do not want to go through the complicated process of secondary listing, but still want to access the world’s largest and most active capital market—the U.S. ADR opens a cheap and efficient door for them.

For investors, the benefits are even clearer. If a foreign company does not issue ADRs, buying its stock can be very troublesome—requiring foreign brokerage accounts, currency exchange, handling remittance procedures, and facing exchange rate risks. But if the company issues ADRs, investors can buy directly in U.S. dollars on American exchanges, just like any other U.S. stock.

ADRs Have Different Levels and Risks

Based on regulatory strictness, ADRs are divided into Level 1, Level 2, and Level 3, as well as sponsored and unsponsored types, with significant differences:

Level 1 ADRs: The loosest regulation, only traded over-the-counter (OTC), minimal disclosure requirements. These ADRs carry higher risks.

Level 2 ADRs: Can be traded on NASDAQ or NYSE, must comply with SEC regulations, including periodic financial disclosures. Moderate regulation.

Level 3 ADRs: The most regulated, not only tradable but also used for fundraising. Full disclosure, suitable for large enterprises.

Sponsored ADRs are initiated by the company itself, with banks signing agreements, with the company maintaining control and paying issuance fees. Unsponsored ADRs may have no company involvement, thus higher risk. For example, Tencent (TCEHY.US), BYD (BYDDY.US), and Meituan (MPNGY.US) are unsponsored ADRs.

How Is ADR Price Calculated? Not a 1:1 Relationship

A common misconception among beginners: ADR prices are not a 1:1 mirror of the company’s domestic stock.

For example, TSMC’s ADR ratio is 1:5, meaning 5 shares of Taiwan TSMC (2330.TW) = 1 ADR (TSM.US). Hon Hai is 1:5, Chunghwa Telecom is 1:10. Different ratios are usually set based on considerations like local stock price, exchange rate, liquidity needs, etc.

If the stock price is too high, it can hinder trading convenience, so companies adjust the ratio. Here are some Taiwan companies’ ADR ratios for reference:

How Do Taiwan Stocks and Taiwan ADRs Differ?

When a company is listed both in Taiwan and via ADRs in the U.S., investors should understand the differences:

Nature: Taiwan stocks are actual shares; Taiwan ADRs are depositary receipts representing shares but are not shares themselves.

Trading Venue: TSMC trades on the Taiwan Stock Exchange under Taiwanese regulation; TSMC ADRs trade on NYSE under U.S. SEC regulation.

Ticker Symbols: Different due to different listing locations. For example, Hon Hai’s Taiwan stock code is 2317, while its ADR is HNHAY.

Investor Base: Taiwan stocks mainly target local Taiwanese investors; ADRs attract global investors.

Conversion Ratio: Buying Taiwan stocks is straightforward—one share equals one share; ADRs require conversion based on the ratio.

Premium/Discount: Although long-term trends of Taiwan stocks and ADRs are similar, short-term differences can occur due to market sentiment, liquidity, etc. For example, at times, the ADR price (converted) may be higher than the Taiwan stock price (premium), allowing arbitrage opportunities.

A-shares Also Have ADR Versions, with Similar Differences

Like Taiwan stocks, A-shares also have ADRs, such as BYD and Great Wall Motors, available for overseas investors. The differences include regulatory bodies (CSRC vs. SEC), exchanges, and investor groups.

What Factors Should Be Considered When Investing in ADRs?

Liquidity Risk

Foreign companies often have lower visibility abroad; ADR trading volume is usually much lower than their local stock trading volume. For example, China Telecom ADR’s average monthly volume is only 145,000 shares, while in Taiwan, the average monthly volume is 12.24 million shares. Low liquidity leads to wider bid-ask spreads and higher transaction costs.

Fundamental Analysis

Like investing in any stock, it’s necessary to analyze the company’s operational status, industry outlook, and policy environment. Especially for Level 1 ADRs, which do not require financial disclosures in the U.S., investors must review financial reports from the company’s local market.

Premium/Discount Phenomenon

Market sentiment, exchange rate fluctuations, and liquidity differences can cause ADR prices to deviate from local stock prices. Premium indicates optimism from foreign investors; discount suggests caution. Experienced investors use these deviations for trading decisions.

Exchange Rate Risk

ADR prices are quoted in USD, but the company’s operations may be in other currencies. Exchange rate fluctuations directly impact ADR performance. For example, converting 30,000 TWD into 1,000 USD to buy ADRs—if the USD/TWD rate drops from 1:30 to 1:25, the same USD amount yields fewer TWD, erasing profits or causing losses.

Pros and Cons of Investing in ADRs

Advantages:

First, lower taxes. Taiwanese investors with gains under 1 million TWD on ADRs do not need to pay income tax, and there are no Taiwan stock trading taxes. Many overseas brokers also charge lower transaction fees than Taiwanese brokers, some even zero, suitable for frequent traders.

Second, diversified investment opportunities. Investors can simultaneously invest in U.S. and global companies on the U.S. stock market. Want to invest in electric vehicles? Hold both Tesla (TSLA.US) and NIO (NIO.US) ADRs to get global industry exposure.

Disadvantages:

For non-U.S. investors, the process is more complicated. Opening overseas brokerage accounts, currency exchange, and deposits involve initial costs and learning curves. Using Taiwanese brokers to buy ADRs may incur fees of 1-2%, which can be more expensive than buying local stocks.

Second, currency risk. ADR trading involves USD and local currency exchanges; fluctuations can offset gains or cause losses. If the company’s local currency fluctuates significantly against USD, the ADR’s value will also be affected.

Investing in ADRs is essentially a combination of “company fundamentals × exchange rate trends × market liquidity,” requiring consideration of more factors than local stock investments.