A must-see for US stock beginners: Complete Guide to ADR Investment

Quick Overview of ADR

Want to trade foreign company stocks on U.S. markets but find the process too complicated? ADR (American Depositary Receipt) is the solution. In simple terms, ADRs are certificates issued by U.S. depositary banks representing foreign stocks, allowing you to invest in overseas companies as easily as trading regular U.S. stocks.

Three Key Features of ADRs:

• Traded on NASDAQ, NYSE, and OTC markets
• Opens U.S. financing channels for foreign companies
• Provides U.S. investors with diversified investment opportunities

How ADRs Work: A Visual Explanation

What is an ADR? Simply put, when foreign companies like TSMC or BYD want to enter the U.S. stock market, they give their shares to a U.S. depositary bank, which then issues ADR certificates for U.S. investors to trade. You can think of ADRs as “foreign companies’ stocks issued on the U.S. stock market,” with operation methods similar to regular U.S. stocks.

For example, TSMC is listed both in Taiwan and the U.S., with the U.S. ticker TSM. U.S. investors don’t need to open a Taiwanese account or exchange TWD; they can buy and sell TSMC ADRs directly in USD on the NYSE — simple as that.

Why Are Foreign Companies Issuing ADRs?

Instead of going through a traditional IPO in the U.S., issuing ADRs is cheaper and simpler. Many companies are already listed in their home countries and want to avoid the complex process of secondary listing, but since the U.S. market is the largest capital market globally, they don’t want to miss out. ADRs become the best choice.

Benefits for Investors Are Clearer:

Without ADRs, U.S. investors wanting to buy TSMC would need to open a Taiwanese brokerage account, exchange TWD, and face currency risk — a complicated and costly process. With ADRs, everything becomes easier — buy directly in USD, just like trading other U.S. stocks.

Two Main Types of ADRs, Different Risks

Sponsored ADRs — Issued proactively by companies

• Issued by banks on behalf of foreign companies, with formal agreements
• Companies control ADR issuance and pay issuance fees
• Must comply with SEC regulations, disclose financial info regularly
• Relatively lower risk

Unsponsored ADRs — Issued by banks independently

• Sometimes companies may not even know
• Only traded on OTC markets
• Lower disclosure requirements, higher risk
• Examples: Tencent (TCEHY.US), BYD (BYDDY.US), Meituan (MPNGY.US)

ADRs Are Divided into Three Levels; Choosing Wrong Can Cost You

Based on the extent of market access in the U.S., ADRs are classified as Level 1, 2, and 3, with increasing regulatory requirements:

Level 1 ADRs have minimal disclosure, lowest liquidity, and highest risk, so beginners are advised to avoid. Levels 2 and 3 are listed on major exchanges and are safer and more transparent.

What Is the ADR Ratio? Why Does 1 Share Become 5 Shares?

This is a common oversight for beginners: ADR and the underlying stock are not 1:1 equivalents.

For example, one ADR of Hon Hai (HNHPF.US) equals 5 shares of Hon Hai Precision (2317.TW). Why? Companies set ratios based on stock price, exchange rate, and liquidity. If the stock price is too high for easy trading, they increase the ratio to make the price more accessible.

Common Taiwan ADR Conversion Table:

Taiwan Stocks vs Taiwan ADRs: Five Major Differences

Why do the same company’s stocks perform differently in Taiwan and the U.S.? Because they are fundamentally different products in two markets.

Different Nature — Taiwan stocks are company shares; Taiwan ADRs are depositary receipts, with different legal nature.

Different Trading Venues — TSMC is regulated by the Taiwan Stock Exchange in Taiwan and by the SEC in the U.S., with completely different rules.

Different Stock Codes — The same company has different ticker symbols in Taiwan and for ADRs, making it easier for investors to distinguish.

Different Investor Bases — Taiwan stocks mainly attract local investors; ADRs appeal to global investors.

Different Conversion Ratios — As shown above, ratios vary by company.

Premium and Discount Phenomenon — This is the most interesting part. Although Taiwan stocks and U.S. ADRs tend to move roughly together, their daily price changes are not perfectly aligned. In early 2023, TSMC experienced a premium where the ADR price, converted, was higher than the Taiwan stock price, indicating that U.S. investors were more optimistic.

Experienced investors often exploit this price difference for arbitrage — selling ADRs when they are at a premium and buying Taiwan stocks, or vice versa.

A-Share Investors Can Also Enter U.S. Markets via ADRs

A-shares and A-share ADRs follow similar logic to Taiwan stocks. Chinese companies like BYD and Great Wall Motors are listed on A-shares and also issue ADRs for U.S. investors.

Four Things to Consider Before Investing in ADRs

1. Liquidity directly affects buying and selling

Foreign companies are well-known locally but less so overseas. Trading ADRs involves fewer investors and lower trading volume. For example, Chunghwa Telecom’s ADR has an average monthly volume of only 145,000 shares, far below the 12.24 million shares traded in Taiwan. Poor liquidity means bigger spreads and slower transactions — always check liquidity before trading.

2. Company fundamentals determine long-term trends

Like regular stocks, investing in ADRs requires analyzing the company’s operations, industry outlook, and relevant policies. Note that some Level 1 ADRs do not require U.S. financial disclosures; you need to check the original country’s financial info.

TSMC ADR rose 32% in January 2023, mainly benefiting from China’s reopening, improved earnings reports, and industry prospects.

3. Premiums and discounts are both trading opportunities and risks

Although ADRs and the underlying stocks tend to move together, they are not perfectly synchronized, leading to discounts or premiums. On March 22, 2023, TSMC ADR was at about a 3.8% premium ($92.6 ÷ 5 × 30 = 553.6 TWD vs. Taiwan stock at 533 TWD). Savvy investors use this difference for arbitrage, but beginners may get caught, so exercise caution.

4. Exchange rate risk cannot be ignored

Investing in ADRs with TWD to USD involves currency risk. If the exchange rate moves unfavorably, your gains can evaporate. For example, investing 30,000 TWD at an exchange rate of 1:30 yields a 20% profit; if the rate shifts to 1:25 when converting back, you might end up with no profit at all. Large currency fluctuations in the country of the company can also cause ADRs to swing more.

Why Consider ADRs? Their Advantages

Clear Tax and Cost Benefits

Taiwan investors can profit from ADR trading without paying tax on gains under NT$1 million. Plus, foreign brokers often charge zero commission, much lower than Taiwan brokers’ 1-2% fees. Frequent traders can save significant costs using ADRs.

Easier Diversification

Want to invest in electric vehicle industry? U.S. stocks like Tesla (TSLA), ADRs like NIO, all in one account. No need to open multiple accounts or learn different rules — ADRs make global investing simple.

Disadvantages of ADRs: Pitfalls for Beginners

Account Opening and Currency Exchange Are Still Complex

Taiwan investors need to open overseas brokerage accounts, exchange USD, and fund accounts before trading ADRs. These steps involve fees and exchange costs. You can also entrust Taiwanese brokers to purchase ADRs on your behalf, but with 1-2% fees, which are more expensive than direct purchase.

Currency Risk Cannot Be Avoided

Investing in ADRs is essentially betting on both stock performance and USD/TWD exchange rate. Even if you pick the right stock, unfavorable currency movements can cause losses. Moreover, in emerging markets, local currency volatility against USD can amplify ADR fluctuations.