Essential Guide to U.S. Stocks | ADR Investment Guide and Practical Tips

A Brief Guide to ADR

What is ADR? Simply put, ADR, or American Depositary Receipt, is a stock certificate that represents shares of a foreign company traded in the U.S. market. For example, if you want to invest in Taiwan’s TSMC or China’s BYD, you don’t need to open an account locally; you can directly buy their ADRs on U.S. stock exchanges—this is the core value of ADRs.

The operation logic of ADRs is actually straightforward: foreign companies deposit their shares with a U.S. deposit bank, which issues corresponding ADR certificates. Investors can then trade these ADRs on Nasdaq, NYSE, or OTC markets just like U.S. stocks.

Why Issue ADRs at All? Two Main Driving Forces

From a company’s perspective, issuing ADRs is much cheaper and simpler than directly listing in the U.S.. Many foreign companies are already listed in their home countries; secondary listing in the U.S. can be a huge burden. ADRs serve as a compromise—allowing access to the world’s largest capital market for fundraising without going through complex listing procedures.

For investors, ADRs solve a big headache. Without ADRs, buying a foreign company’s stock requires: opening a securities account in that country → exchanging currency into local currency → bearing exchange rate risk → understanding local trading rules. The whole process is cumbersome and costly. With ADRs, everything simplifies to: placing an order in USD in a U.S. stock account, just like buying Apple stock—easy and convenient.

ADRs Come in Two Main Types, with Significant Risk Differences

Sponsored ADRs vs Unsponsored ADRs—this distinction is crucial.

Sponsored ADRs are issued at the initiative of the foreign company, which entrusts a U.S. deposit bank to issue them. The company retains control and pays fees to the bank. The advantage is that these ADRs must comply with SEC regulations, regularly disclose financial information, and are traded on Nasdaq or NYSE, ensuring liquidity and compliance.

Unsponsored ADRs may have no direct involvement from the original company and are often pushed by deposit banks. They are traded only in the OTC market. Examples include Tencent (TCEHY.US), BYD (BYDDY.US), and Meituan (MPNGY.US). These carry higher risks and tend to have lower liquidity.

Additionally, ADRs are classified into three levels: Level 1 (least regulated, OTC trading only), Level 2 (strictly regulated, exchange trading), Level 3 (most regulated, with fundraising capabilities). The higher the level, the stricter the regulation and the lower the investment risk.

ADR Ratios Are Not 1:1, Must Be Clear

This is a common pitfall: The conversion ratio between ADRs and the underlying foreign shares is not 1:1.

For example, Hon Hai (Foxconn) has a ratio of 1:5, meaning 5 shares of Taiwan Hon Hai (2317.TW) equal 1 Hon Hai ADR (HNHAY). TSMC also has a 1:5 ratio, while Chunghwa Telecom (CHT) is 1:10. These ratios are mainly set based on stock price, exchange rate, and liquidity considerations. If the stock price is too high, it can hinder retail trading, so companies adjust ratios to keep prices within a reasonable range.

Typical Taiwan ADR ratios:

• TSMC: 1:5
• Hon Hai: 1:5
• Chunghwa Telecom: 1:10
• ASE: 1:5

Six Key Differences Between Taiwan Stocks and Taiwan ADRs

When a company is listed in Taiwan and also issues ADRs in the U.S., how do they differ?

Nature: Taiwan stocks are actual shares; ADRs are certificates representing those shares.

Trading Venue: Taiwan stocks trade on the Taiwan Stock Exchange, regulated by Taiwan authorities; ADRs trade on NYSE or NASDAQ, regulated by SEC. The regulatory systems and disclosure standards differ.

Stock Codes: Hon Hai in Taiwan is 2317; its ADR is HNHAY.

Investor Base: Taiwan stocks mainly target local investors; ADRs are aimed at global investors.

Conversion Ratio: Buying one Taiwan stock equals one share; buying ADRs is limited by the ratio (e.g., 1:5 means one ADR represents five Taiwan shares).

Premiums and Discounts: Although overall trends are correlated, daily prices can deviate due to exchange rates, supply and demand, and market sentiment. This creates premiums or discounts—ADR prices may be higher or lower than the equivalent local stock price. Some investors exploit these differences for arbitrage.

Three Core Considerations When Investing in ADRs

Liquidity issues cannot be ignored

Foreign companies often have much lower visibility in overseas markets compared to their home markets. For example, China Telecom (CHT.US) has an average monthly trading volume of about 145,000 shares in the U.S., but on March 13, its Taiwan stock’s average monthly volume was 12.24 million shares—huge difference. Low liquidity means it may be difficult to buy or sell quickly, and spreads can be large.

Fundamental analysis remains key

Investing in ADRs is similar to investing in any stock: analyze the company’s operations, industry outlook, policy impacts, etc. Note that Level 1 ADRs in the U.S. may not be required to disclose financial reports; investors need to proactively review the company’s financial info published in its home market.

For example, TSMC’s ADR surged 32% in early 2023, driven by factors like reopening of the domestic pandemic, strong quarterly earnings, and industry upturn—these are fundamental factors.

Premium and discount trading mechanisms

When the ADR’s converted price deviates from the local stock price, premiums or discounts occur. For instance, on March 22, 2023, TSMC ADR closed at $92.6. Using a 1:5 ratio and exchange rate, this equates to 553.3 TWD, while the same day’s Taiwan stock closed at 533 TWD, creating a premium. Some investors sell ADRs when premiums appear and buy the local stock, or vice versa, to profit from these differences.

Pros and Cons of Investing in ADRs

Advantages:

1. Tax Benefits: For Taiwanese investors, profits under 1 million TWD from ADR trading are tax-free; no transaction tax, much lower than Taiwan stock taxes.
2. Lower Fees: Many overseas brokers offer zero commission, reducing costs for frequent trading.
3. Diversification: Enables direct investment in global companies beyond U.S. stocks, e.g., investing in Tesla (TSLA) and NIO (NIO) simultaneously.

Disadvantages:

1. Complex Process: Requires opening an overseas broker account → exchanging currency into USD → depositing funds for trading; initial costs and time are significant. Using Taiwanese brokers for proxy purchases involves 1-2% fees, increasing costs.
2. Exchange Rate Risk: Trading in USD exposes you to currency fluctuations. Even if your investment gains 20%, a decline in USD value can erode or even wipe out your profits.
3. Currency Volatility Risk: If the company’s home currency and USD fluctuate sharply, ADR prices will also fluctuate, increasing investment complexity.

Ultimately, investing in ADRs is about balancing convenience and cost, and should be tailored to your capital size, trading frequency, and risk appetite.