Transcript Document

Investment Analysis
Lecture 6
ADRs & Global Industry Analysis
Investment Analysis
American Depository Receipts (ADRs)
• An American Depository Receipt (ADR) is a dollardenominated negotiable certificate representing a
specified number of shares in a foreign corporation.
• ADRs are issued by US banks and consist of a bundle of
shares of a foreign corporation that are being held in
custody overseas. ADRs are listed in the US and traded
like regular stocks on the NYSE, AMEX and NASDAQ.
Investment Analysis
American Depository Receipts (ADRs) (cont’d …)
• The foreign entity must provide financial information
to the sponsor bank. The ADR can be cancelled and
redeemed for its underlying shares at anytime.
• The advantage of ADRs is that they reduce
administration and duty costs on each transaction. The
disadvantage of ADRs is that they do not eliminate the
inherent currency and economic risks associated with
the shares of a foreign currency.
Investment Analysis
Types of ADRs
There are three different types of ADR issued:
1. Level I: This is the most basic type of ADR, used by
foreign companies that either do not qualify or do not
wish to have their ADR listed on an exchange. Level I
ADRs trade solely on the over-the-counter market and
are an easy and inexpensive way for a company to
gauge interest for its securities in North America.
Level I company ADRs are not required to comply with
SEC registration and reporting requirements.
Investment Analysis
Types of ADRs (cont’d …)
• Level II: This type of ADR is listed on an exchange or quoted on any
official US stock exchange, including the NYSE and NASDAQ. Level II
ADRs meet the registration requirements of the SEC, but they also
get higher visibility trading volume. The company must report an
annual reconciliation of earnings and shareholders’ equity from its
country’s national accounting standards to US GAAP, as well as
quarterly statements.
• Level III: This is the most prestigious of the three types in which an
issuer floats a public offering of ADRs on a US exchange. Level III
ADRs enable the issuer to raise capital and gain visibility in the US
financial markets. The reporting requirements for Level III ADRs are
the same as they are for Level II.
Investment Analysis
Reasons for Issuing ADRs
There are four reasons why a company may want to list its
securities abroad:
1.
2.
3.
4.
It may desire a broader diversification of its capital sources across
international boundaries.
Concern over takeovers by domestic competitors is minimized by
global diversification of the company’s shares.
In the case where a company wants to raise additional external
financing, exposure to broader capital markets provides access to
additional resources.
Listing a company abroad provides additional advertising
opportunities for the company’s products and services.
Investment Analysis
Reasons for Issuing ADRs (cont’d …)
ADRs provide a means of obtaining international
diversification with relative ease. Generally, it is more
costly for large institutional investors to purchase ADRs
than to directly purchase the securities in the local
market, since the local market may provide more
liquidity. When evaluating the cost tradeoff of using
ADRs or directly purchasing the shares in the primary
market, the investor looks at price levels, transaction
costs, taxes and administrative expenses.
Investment Analysis
Trading Costs of Listed Shares v/s ADRs
Unilever (US) (UK) shares are listed in Frankfurt
(XETRA) and on the NYSE. A German investor purchases
100 shares of UK in Frankfurt at €51.45 per share. The
broker in Germany charges a 0.10% commission.
Simultaneously, the investor’s US broker quotes
Unilever US ADRs on the NYSE at an ask price of
$60.60, net of commissions. The exchange rate in US
dollars per euro is 1.1700. Determine whether it is
cheaper to purchase the shares of UK in New York or in
Frankfurt?
Investment Analysis
SOLUTION
•
The purchase price of 100 shares listed on NYSE is $6,060, to pay for the purchase,
the investor will need to exchange Euros for US dollars at a rate of $1.1700 per
Euro for a total Euro purchase of:
$6,060
=
€5,179
$1.17/€
•
The cost of purchasing the 100 shares of UK directly from Frankfurt is the purchase
price plus the 0.10% commission:
€51.45 x 100 x 1.0010 = €5,150
•
A savings of €29 per 100 shares would be realized if the shares were purchased
directly in Frankfurt as opposed to buying the ADRs in New York.
Investment Analysis
Global Industry Analysis
Country Analysis
Expected real economic growth is the most
important variable to analyze in a country
analysis because it has the most significant
influence on the risk and returns in national
equity markets.
Investment Analysis
Global Industry Analysis (cont’d …)
Analysts are interested in forecasting expected economic
growth in the short run and the long run:
• In the short run, the focus is on forecasting the stage in the
business cycle and therefore, expected short-term
economic growth.
• In the long run, the focus shifts to expectations of
sustainable economic growth as measured by growth in per
capital gross domestic product (GDP).
Investment Analysis
Global Industry Analysis (cont’d …)
Business Cycle
• The short-term goal in identifying the current stage in the business cycle is
to forecast the turning points when the economy moves from one stage to
another and then invest in those sectors or industries that are expected to
perform best during that stage.
• In most cases this is difficult to do with any degree of success, which is
why analysts most often focus on long-run forecasts of sustainable
economic growth. However, there are opportunities to earn excess riskadjusted returns for the analyst who can identify and exploit the various
stages of the business cyclic better than others can.
The concept of business cycles will be discussed again in next lecture under
industry analysis and number and classification of the cycles will differ. The
following is based on Calverley (2003)
Investment Analysis
Attractive Investments in Various Business Cycle Stages
Business Cycle Stage
Description
Attractive Investments
Recovery
Economy begins to recover from
recession
•Cyclical Stocks
•Commodities
•Other risky assets
Early upswing
Consumer confidence improves;
economic growth rate increases
•Stocks
•Real Estate
Late upswing
Peak growth rate; also knows as
“boom” period
•Bonds
•Interest-sensitive stocks
Economy slows
Declining growth; interest rates
fall
•Bonds
•Interest-sensitive stocks
Recession
Low point of economic growth;
government eases monetary
policy stimulate growth
•Stocks
•Commodities