“I found the www.companysleuth.com that you recommended particularly helpful. The ‘short interest’ feature it offers on all NASDAQ stocks is particularly useful. My question for you relates to investing in American Depository Receipts. In many cases the performance of a company’s ADRs diverges from the stock price in its home market. For example, Colt Telecommunications quoted on the London Stock exchange has had a significantly different performance the past six months from its ADRs, traded here on NASDAQ. How come?” – Brian Riordan
A.T.: First of all, what’s an ADR? From a U.S. investor’s point of view, it’s a convenient way to buy shares in some big foreign company without having to open a brokerage account over there or persuade his U.S. broker to call up the Finnish Stock Exchange, or whatever. Often, each ADR will represent more than one share of stock in the underlying company. (That stock is held by a custodian, like J.P. Morgan, which takes care of things like getting you your share of dividends.)
That’s the basic idea. And the basic answer to your question is: nevva happen.
ADRs never perform much differently from their underlying securities. The minute they began to diverge in any significant way, international arbitrageurs would jump in and grab the profit to be made from the difference, thereby bringing them back in line.
It is possible for there to appear to be a major discrepancy, however, for one interesting reason: ADRs declare stock splits at times that are totally unrelated to stock splits in the underlying securities. As I say, one ADR doesn’t necessarily equal one share of the underlying foreign security. Especially because London securities sell at much smaller unit prices than U.S. securities, a common ADR might equal 10 shares of the London stock. If the London stock happens to declare a 2-1 stock split, the ADR will simply equal 20 shares of the London stock instead of 10. In the U.S., stocks rarely go over $100 per share without a split, so when an ADR goes into triple digits, the U.S. sponsor may well declare its own 2-1 stock split, and suddenly an ADR only represents 5 shares of the London stock instead of 10.
ADRs are a safe and convenient way to invest in the shares of overseas companies, and any apparent differences in performance should be explainable as (1) currency fluctuation, (2) minor effects of different closing times of exchanges, and/or (3) stock splits in both countries. Comparisons of ADRs with their securities consistently show correlations exceeding 99%.