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What is an American Depository Receipt?

Posted By Jim On 04/23/2008 @ 1:19 pm In Investing | 1 Comment

If you ever wanted to buy shares of L’Oreal, you probably were introduced to the idea of an American Depository Receipt. American Depository Receipts, or ADRs, are constructs that allow you to purchase ownership interest (stock) in foreign companies on the domestic stock market.

It’s actually a pretty simple construct. The ADR is a certificate issued by a US depository bank and represents a share (could be a fraction, whole, or multiple shares) of a foreign stock the bank is holding overseas. The ADRs are issued in terms of US dollars but the underlying security is still held in the country of origin’s currency. The whole point of ADRs is that it makes it easier and more convenient to own foreign shares. Instead of having to open a brokerage account overseas, transfer the funds, convert them into the local currency, and then make the purchase – you just buy an ADR. (that’s just one-way, so double that headache). You can tell if a stock is traded as an ADR because it will generally have (ADR) next to its name (as L’Oreal [3] does on Google Finance).

From the operations perspective of yourself, the investor, there is no difference between buying and selling shares of stock and ADRs. You just need to be aware that in addition to all the risks associated with investing in the domestic stock market, you’re introducing currency and country risk into your portfolio. Currency risk refers to the exchange rate of the dollar and the local currency. Country risk refers to the risk associated with changes in the local country’s economy. In the domestic stock market, all holdings are in dollar and you’re contained within the US economy (for the most part, though the World Is Flat [4]) so you don’t have to account for currency and country risk (from the local country).

(If you want to get technical, an ADR is the actual certificate where as an American Depository Share, ADS, is the actual share. An ADR can represent multiple ADSs. In colloquial use, ADR refers to both.)

According to Wikipedia [5], the first ADR was introduced by JPMorgan in 1927 for a British retailer named Selfridges&Co. The largest depository bank is the Bank of New york Mellon.


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[3] L’Oreal: http://finance.google.com/finance?q=OTC:LRLCY

[4] World Is Flat: http://www.bargaineering.com/articles/r/amazon.php?asin=0312425074

[5] Wikipedia: http://en.wikipedia.org/wiki/American_Depositary_Receipt

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