Consider Your Options in Foreign Stocks

Physician's Money Digest, September30 2004, Volume 11, Issue 18

Alack of enthusiasm for domestic investmentsin the current economic situationmay force some to search abroad for higherreturns. But foreign stock purchases canbe complicated due to currency conversions, the lackof financial reports from foreign companies, andnonexistent listings in American exchanges. They alsopresent certain unique risks, which could result ingreater share price volatility, such as political and economicchanges. They require more careful researchand planning than most domestic securities, but theextra effort may prove to be worthwhile.

So how do you get ahold of foreign stock? Use thefollowing information as you consider your options incompanies overseas.

What Is an ADR?

In 1927, American Depository Receipts (ADRs)were first introduced by J. P. Morgan Bank when thebank purchased shares of British Retailer SelfredgeStores. J. P. Morgan held the actual stock certificates ofthe British company, but issued receipts to buyers on theNew York Stock Exchange.

ADRs are created when a foreign company depositsshares of their stock into an American bank. The bankdoesn't sell the actual stock shares; rather, it issuesreceipts that represent the shares of the foreign company.The bank holds the shares, collects the dividends,makes currency conversions, and pays the dividends tothe receipt holders in US dollars.

In the past, foreign companies used ADRs to createstock purchase plans for their US-based employees. Butsince the 1980s, ADRs have increased in popularity asan investment option for mutual funds and individualslooking into foreign markets. Currently, the Bank ofNew York is the largest dealer in ADRs.

ADRs offer many benefits to potential buyersinterested in foreign stock. Unlike other foreign stockoptions, ADRs pay dividends in US dollars and arelisted on American exchanges. For example, you canbuy Volvo ADRs on the Nasdaq under the stock symbolVOLVY.

Technically, an ADR is a receipt for an AmericanDepository Share (ADS). The ADS represents a specificnumber of shares of a foreign company, and is the actualsecurity used in trading. However, the term "ADR"generally refers to both the receipt and the security.

Sponsored vs Unsponsored

Sponsored ADRs offer the easiest method for foreigncompanies to issue securities in the United States; theyare tradable on the New York Stock Exchange or theover-the-counter market. The underlying companiesusually supply fundamental information on their business,just like most American companies. Also,exchange-listed companies must provide better financialinformation than unsponsored ADRs and nonexchangelistedADRs. To qualify for listing, foreign companiesmust complete extensive filings with United States governingbodies and provide financial reports similar tothose of domestic companies.

On the other hand, unsponsored ADRs are createdwithout the consent of the underlying foreign company,and at one time commanded the majority of availableADRs. Now they are becoming less and less popularbecause the foreign companies do not report their financialinformation to the United States, making researchmore difficult for investors. These securities may be handledby more than one bank and are not listed onAmerican exchanges.

What Is an ORD?

ORDs offer another option for investors interested inforeign markets. The letters ORD are short for "ordinaries"and they refer to ordinary shares of non-US companiestrading on a foreign exchange. Unlike ADRs,these securities are purchased and pay dividends in thecompany's local currency. They are not traded onAmerican exchanges and must be purchased through abrokerage firm local to the company.

For example, you can buy shares of CannonCorporation with yen on the Tokyo Stock Exchangethrough a Japanese brokerage firm or bank. However,many American brokerage firms will buy ORDs, handlethe currency conversions, and price the shares in US dollars,but they charge fees for these services. And in thiscase, the ORDs will be held at an overseas branch of thebrokerage firm or bank.

Which Is Better?

Many benefits of ADRs exist for investors looking toapproach foreign securities. First, they are much moreconvenient than ORDs, because you don't need to worryabout currency conversions for purchases and dividendpayments, or wiring money out of the country. ADRsalso use the standard settlement time frame of 3 days,while ORDs normally take anywhere between 2 and 5days. Also, ADRs' annual reports are printed in English,whereas ORDs' may be in a foreign language.

Information on ADRs is easier to access than onORDs, and ADRs eliminate the need for expensive internationalcommunications. ADRs that trade on Americanexchanges must file Form 20-F reports, which are similarto the annual reports filed by domestic companies.Even nonlisted ADRs usually publish an English versionof their annual reports for shareholders.

ADRs are very liquid and can be easily sold andconverted to cash. To enhance this liquidity, someADRs can be converted to ORDs and sold in theunderlying company's home country.

Finally, you can easily obtain price quotes onexchange-listed ADRs, but nonlisted ADR and ORDquotes may be more difficult to find. For a quote onan ORD, you can look in the foreign market sectionof some domestic business papers for an approximatemarket value in US dollars, or you can get a quotefrom your broker.

However, you should also consider the drawbacks ofADRs. One negative aspect of ADRs is the extra costsinvolved in their creation. The banks that issue ADRsmay also keep part of the dividend to cover these services.These extra service fees don't exist when you purchaseORDs or domestic stocks. Also, ADRs are notalways available for smaller growth companies; usuallyonly large overseas companies issue them.

Fluctuations in currency against the US dollar canaffect the value of ADRs. Therefore, an ADR's price onthe American exchange will closely track the price of theforeign stock on its local exchange after adjusting forchanges in the local currency.

The final drawback worth considering is the lack offinancial reporting for unsponsored ADRs or those tradedover-the-counter, which don't require the samereports as listed stocks.

Future of Foreign Investments

While ADRs seem like a viable option right now,they may not survive for the long term. In comingyears, the number of ADRs issued will continue toincrease. However, the choice between ADRs andORDs may become moot. Eventually, exchangesaround the world will become more linked electronically,physical stock certificates will be replaced withelectronic records, and competition between banksthat issue ADRs will drive down service charges. Thecombination of these factors may make ADRs obsoletein the future, and make ORDs the security ofchoice for investors interested in foreign stocks.

However, as with any other investment decision,consider your personal financial needs before decidingbetween an ORD and an ADR. Base your choice onthorough research and careful planning. When youuse that information as a guide to foreign investments,you are better able to make an educated decision andprotect your financial future.

Douglas Charney is vice president of investments

with Wachovia Securities, LLC, in Harrisburg, Pa.

He welcomes questions or comments at 888-529-

2973 or dcharney@wachoviasec.com, or visit

www.charney.wbsec.com. Wachovia Securities,

LLC, member New York Stock Exchange and

Securities Investor Protection Corporation, did not

assist in the preparation of this article. The article's accuracy and completeness

are not guaranteed. The opinions expressed are those of the

author and not necessarily those of Wachovia Securities or its affiliates.