Quick Guide for US Stock Beginners: Quickly Understand the Meaning of ADR and Key Investment Points

What is ADR? Explained in One Sentence

ADR stands for American Depositary Receipt, which simply means: a “substitute stock” issued by foreign companies in the US, allowing US investors to buy and sell foreign company shares directly on US stock exchanges.

How does it work specifically? Foreign companies deposit their shares with a US depositary bank, which issues ADR certificates. Investors are not actually buying the real shares but certificates representing those shares. However, for investors, buying and selling ADRs is no different from trading regular US stocks—traded on Nasdaq, NYSE, or OTC markets, with the same price movements.

For example, TSMC issues Taiwan stocks (ticker 2330) in Taiwan, but also issues ADRs on the New York Stock Exchange (ticker TSM.US). This way, investors worldwide can buy TSMC directly in USD without opening a Taiwan brokerage account.

Why Do Foreign Companies Issue ADRs?

For issuing companies, ADRs are like a “lazy listing” option—many foreign firms are already listed domestically but want to access US capital markets for fundraising. The ADR process is simpler and cheaper than a secondary listing.

For investors? Without ADRs, buying foreign company stocks is complicated: opening foreign brokerage accounts, currency exchange, learning local trading rules, and bearing exchange rate risks. With ADRs, it’s much easier—buy in USD on US exchanges just like Apple stock.

This is why more foreign companies are willing to issue ADRs—they can raise funds in the US and attract global investors.

There Are Two Types of ADRs, with Different Risk Levels

Sponsored ADR vs. Unsponsored ADR

Sponsored ADRs are issued proactively by the foreign company, which signs an agreement with the US depositary bank. The bank charges fees, but the company retains control and must comply with US SEC regulations, including regular financial disclosures. They are relatively safer.

Unsponsored ADRs may be issued without the company’s involvement, often by a bank alone, usually traded OTC. Examples include Tencent (TCEHY.US), BYD (BYDDY.US), Meituan (MPNGY.US). They carry higher risks and lower liquidity.

ADRs are classified into three levels, increasing in strictness:

Level 1 ADRs: Only traded OTC, minimal regulation, least disclosure, suitable for small foreign companies. Highest risk.

Level 2 ADRs: Traded on Nasdaq or NYSE, require more regulatory filings (like Form 20-F), higher compliance.

Level 3 ADRs: Highest level, can be used for trading and fundraising, listed on main exchanges, most regulated. Large companies like TSMC, Hon Hai are mostly Level 2 or 3.

ADRs Are Not 1:1, Ratios Matter

The key to ADRs is the exchange ratio. For example, Hon Hai’s ADR ratio is 1:5, meaning 5 shares of Taiwan Hon Hai equals 1 ADR. This ratio is usually set based on stock price, exchange rate, and liquidity needs.

Here are some common Taiwan companies’ ADR ratios:

Why adjust the ratio? If the stock price is too high, it affects liquidity and trading interest. Adjusting the ratio helps keep the ADR price within a reasonable range.

Differences Between Taiwan Stocks and Taiwan ADRs: Five Points

The same company’s Taiwan stock and US ADR may seem similar but differ greatly:

1. Nature: Taiwan stock is real equity; ADR is just a certificate representing the stock.

2. Trading Venue: Taiwan stocks trade on Taiwan exchanges (regulated by Taiwan), ADRs trade on US exchanges (regulated by SEC).

3. Ticker Symbols: Hon Hai is 2317 in Taiwan, HNHAY in ADR.

4. Investor Base: Taiwan stocks mainly attract local Taiwanese investors; ADRs mainly attract overseas investors.

5. Price Movements: They may not move exactly in sync daily, leading to premiums or discounts.

What is a premium/discount? When the ADR price (converted to local currency) is higher than the local stock price, it’s a premium (indicating overseas investors are more optimistic); a discount indicates the opposite. For example, if TSMC ADR ratio is 1:5, and the ADR closes at $92.6, converted to TWD about 553, while the Taiwan stock closes at 533 TWD, there’s a 20 TWD premium. Some investors try to arbitrage this price difference.

A-Share Investors Must Know: The Parallel World of A-Share ADRs

A-shares and A-share ADRs follow similar logic to Taiwan stocks. Many large Chinese companies like BYD, Great Wall Motors issue both A-shares and ADRs.

Prices can differ due to policies, exchange rates, market sentiment, creating arbitrage opportunities.

Three Major Risks to Consider Before Investing in ADRs

1. Liquidity Risk

Many foreign companies are less known internationally, so ADR trading volume is lower. Also, ADR issuance is smaller than regular stocks, leading to potential liquidity shortages.

For example, China Telecom (CHT.US) has an average monthly trading volume of only 145,000 shares in US markets, while in Taiwan, the monthly average is 12.24 million shares. Poor liquidity means wider bid-ask spreads and higher costs.

2. Exchange Rate Risk

ADRs are traded in USD, so investors face both market risk and currency risk. If you buy ADRs with 30,000 TWD at an exchange rate of 1:30, you get 1,000 USD. If your investment gains 20%, you have 1,200 USD, but if the exchange rate drops to 1:25, converting back yields only 30,000 TWD—profit in USD but loss in exchange rate, resulting in no net gain.

This is an unavoidable cost for ADR investors, especially during volatile currency periods.

3. Incomplete Information Disclosure

Level 1 ADRs in the US do not require detailed financial reports, so investors must seek company info from foreign markets themselves. Unlike Taiwan, where financial reports are transparent, this poses a challenge for investors lacking international financial analysis experience.

Realities of ADR Investment: Pros and Cons

Advantages

Lower Tax and Fees: Taiwanese investors profit from ADRs with less than 1 million TWD, exempt from income tax, and no stock transaction tax. Many overseas brokers also offer zero-commission trading, with much lower fees than Taiwanese brokers.

More Investment Options: Through ADRs, you can invest in top global companies. Want to invest in electric vehicles? Not only Tesla (TSLA.US), but also NIO (NIO.US) from China, diversifying your portfolio.

Disadvantages

Account Opening and Currency Exchange Hassles: Need to open overseas brokerage accounts, convert TWD to USD, and deposit funds before trading. Initial costs and time are significant. Using Taiwanese brokers to purchase ADRs incurs fees of 1-2% or more.

Hidden Currency Risks: Besides stock price movements, watch the USD exchange rate. USD appreciation benefits you; depreciation hurts. This adds an extra layer of risk for ADR investors.

In summary, ADRs are a gateway to global investment, but thorough research is essential—understand company fundamentals, monitor exchange rates, and pay attention to liquidity—to profit steadily in the ADR market.