ADRs/ADSs: The US stock markets are by far the largest in the world, in terms of market capitalization of the listed companies. There is plenty of liquidity and high-quality companies can fetch high valuations. As a result, very often foreign companies opt to list their shares on one of the two main US markets -- the Nasdaq or the New York Stock Exchange (NYSE) -- beyond their local stock market, to benefit from the diverse pool of investors.
This can be done by issuing US dollar-denominated certificates, called American Depositary Receipts (ADRs). These investment vehicles trade like common stocks and track the price of the stock listed on a foreign stock exchange. ADRs essentially allow American investors to easily invest in foreign companies. Without ADRs, investors would need to open local brokerage accounts to get access to local stocks. These certificates eliminate the complexity of investing in international companies while providing investors with the same rights as real stocks. For example, if a foreign company pays a dividend, ADR holders will also receive the dividend payment.
One ADR doesn’t necessarily represent one foreign share. It can represent multiple shares or a fraction of a share. This is a significant difference between ADRs and traditional stocks. Investors should be aware of the exchange rate because it impacts valuation metrics such as the P/E and the P/S ratios. Investors might come across the term ADS which stands for American Depositary Shares. This means that a US bank holds the actual shares of a foreign company, but they are denominated in US dollars. The certificate based on an ADS is known as an ADR, and that is what US investors buy and sell. The two terms are often used interchangeably.
There are three different types or “levels” of ADRs.Level 1 ADRs are subject to limited SEC reporting requirements and may trade over the counter but not on the Nasdaq or NYSE. These stocks are typically risky, illiquid, and is difficult for investors to find up-to-date information about their underlying fundamental performance.
Level 2 and Level 3 ADRs have strict SEC reporting requirements and trade on the two main stock markets. Level 3 ADRs reflect an IPO, which means that the foreign firm raised funds by issuing and selling new shares.
Finally, ADRs often come with some small fees, known as custody fees. The bank is compensated for providing custodial services through these fees, which normally vary between $0.01 and $0.03 per ADR every year. Fees can be seen on a company's Investor Relations homepage under the section named "Description of American Depository Shares" or "Description of American Depository Receipts."
Foreign companies that are listed on one of the two major American stock markets, the Nasdaq or the NYSE, are required by the SEC to submit documents that provide valuable information to investors. They are required to submit three main documents: Form 20-F, Form 40-F, and Form 6-K. Let’s see what these forms are, why they are important, and what investors should look at when analyzing them.
Form 20-F: Form 20-F is the equivalent of Form 10-K or the annual report for non-US and non-Canadian companies. The reporting requirements are not as strict as the requirements for domestic companies. This form must be filed within four months after the end of the company’s fiscal year.
Form 20-F is a very important document as it standardizes the reporting process of all companies, regardless of the country they are based in. It allows investors to get accurate information about the company’s operations, financial conditions, risk factors, management, and others. In many cases, Form 20-F is the only source of detailed information investors can find about a company, especially when it is based in a non-English-speaking country which makes it more difficult for individual investors to analyze information.
Investors should review this section which includes the company’s description of its business operations, including its products, services, markets, and competition. This can help investors understand the company’s industry and its competitive position within that industry.
Investors should review the company’s financial statements such as the balance sheet, the income statement, and the cash flow statement. These statements can provide investors with valuable information about a company’s financial health and performance.
Just like a 10-K filing or annual report, a 20-F filing includes a risk factors section. Investors should review this section as it describes the risks and uncertainties that could affect a company’s operations and financial performance. These risks can help investors understand if the company is appropriate for the level of risk they are willing to take.
This is a very important section in a 20-F filing as it provides management’s analysis of the company’s financial performance and results of operations. By reviewing this section, investors can discover the drivers behind the company’s financial results and make better investment decisions.
Companies that are based in Canada but are listed on a major US stock exchange are required to file an annual report, which is called Form 40-F. Companies need to file this form within 120 days after the end of their fiscal year. Form 40-F is similar to Form 20-F and Form 10-K. It provides information about the company’s business operations, financial conditions, and management, among others. Investors who want to invest in Canadian companies listed in the US should review the most recent Form 40-F to find the necessary financial and other information and make informed decisions. Shopify ($SHOP) and Lululemon ($LULU) are two high-profile Canadian companies that are listed in the US. The key areas investors should focus on when reviewing Form 40-F are the same as the areas of other annual fillings, such as the 10-K and the 20-F.
The reporting requirements of foreign companies that are listed in the US are not as strict as the requirements for domestic companies. Form 6-K is the only document other than the annual report that foreign companies are required to file with the SEC. Companies must file this form promptly after material information is made public. As material information is considered: earnings reports, changes in management or auditors, M&A activity (Mergers & Acquisitions), events related to the company’s securities such as stock splits, and any other information that investors need to know.
6-K filings are very important documents for individual investors who may not have access to real-time data and recourses in foreign, often non-English speaking countries. The SEC requires companies to file Form 6-K in English to ensure that American investors have access to important information about foreign issuers.
A Form 6-K can be as short as 3 pages when the company reports information such as management changes, but it can be significantly lengthier when the company reports quarterly earnings. In this case, a Form 6-K is similar to a Form 10-Q that domestic companies are required to file quarterly when they report earnings results.
The SEC has created forms and certificates to standardize the process of investing in and analyzing foreign companies that are listed in the US. ADRs/ADSs allow Americans to easily invest in foreign companies without having to deal directly with foreign stock markets, brokers, and currencies. Forms 20-F, 40-F, and 6-K were also created to help investors easily find accurate and detailed information on foreign companies that trade on major American exchanges. By analyzing these filings, investors can make informed investment decisions without needing to search for credible information in local sources.
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