How to understand ADRs in the stock market: A guide for Indian investors

6 minutes read

23 December 2024

How to understand ADRs in the stock market: A guide for Indian investors

Did you know that more than 15 Indian companies trade on the New York Stock Exchange through ADRs? This gives global investors direct access to India's growing economy.

Most investors know about US stocks, but American Depositary Receipts (ADRs) are a chance to invest in international markets. You can buy shares of foreign companies directly through US stock exchanges with these financial instruments.

ADRs create a convenient gateway to global investing for Indian investors who want to expand beyond domestic markets. They function just like regular stocks and represent ownership in shares of foreign companies. Major Indian corporations like Infosys, ICICI Bank, and Tata Motors trade through ADRs.

Let's explore how ADRs can strengthen your investment strategy. This piece covers everything from simple concepts to practical investing steps that you need to know.

What are ADRs, and why do they matter for Indian investors?

American Depositary Receipts (ADRs) connect you to international markets through US stock exchanges. These negotiable certificates, issued by US depositary banks, represent ownership in shares of foreign companies.

Basic concept and structure of ADRs

Investing in an ADR means buying a certificate representing shares of a non-US company held by a US bank. Each ADR can represent one share, multiple shares, or even a fraction of a share in a foreign company. US financial institutions store the underlying shares, usually through their overseas branches.

Benefits for Indian investors

Your investment portfolio can gain several advantages through ADRs:

Trade in US dollars, eliminating currency conversion hassles
Easy access through American brokers
Clear through US settlement systems
Provide straightforward tax reporting under US regulations

Popular Indian companies with ADR listings

Many major Indian companies run successful ADR programmes. HDFC Bank is the largest Indian company by market capitalization, with an ADR listing, and holds a 13.3% weightage in the Nifty 50 index. Notable Indian companies with ADR listings include:

Infosys, which achieved industry-leading revenue growth of 15.4% in FY2022-23
ICICI Bank, the first Indian bank from Asia ex-Japan to list on NYSE
Dr. Reddy's Laboratories, which wants to reach 1.5 billion patients by 2030
Wipro, which excels in innovative technology solutions

How do ADRs work in practice?

Understanding the mechanics of ADRs in daily trading can help you make informed investment decisions. Let's explore how these financial instruments work.

ADR creation and trading process

A US bank starts the process by purchasing shares of a foreign company to hold as inventory. These banks issue ADRs that trade on US exchanges, making them available like domestic shares. Buying an ADR gives you a certificate representing ownership of the underlying foreign shares, and you can trade it in US dollars.

Price relationship with underlying shares

ADR prices reflect several factors:

Changes in the underlying foreign security's value
Currency movements against the US dollar
US market conditions and trading hours
Systematic risk evaluation against US market indices

ADR prices can move even when the home market is closed because they trade during North American hours. Arbitrage opportunities keep the price close to the value of the underlying shares.

Converting between ADRs and regular shares

ADRs can be converted into regular shares and vice versa through issuance and cancellation. Properly executing this conversion takes about 24 hours. The ADR ratio—the number of underlying shares per ADR—varies by company. If the ratio is 2:1, one ADR represents two ordinary shares.

The conversion process needs coordination between your broker, the depositary bank, and custodians in both markets. The depositary bank's issuance fee can reach US$21.10 per ADR.

Step-by-step guide to investing in ADRs

Want to invest in ADRs? Here's a practical guide to begin your investment trip into international markets.

Setting up an overseas trading account

You can invest in ADRs from India through platforms connecting to US markets. Here's what you need to do:

Pick a trusted trading platform with US market access
Finish your KYC verification
Connect your bank account to transfer funds
Convert your Indian Rupees to US Dollars
Turn on international trading features

Selecting suitable ADR investments

These are the most important factors to look at while picking ADRs:

Make sure the company sponsors the ADR - unsponsored ADRs trade over-the-counter and carry higher risks
Look at the ADR's trading volume and exchange listing - NYSE or NASDAQ listings give you better liquidity
Go through the company's Form 20-F financial reports
The ADR's custody fees range from one to three cents per share

Executing ADR trades effectively

ADRs trade just like regular stocks on US exchanges. Your trades and dividends will be in US dollars.

Currency exchange rates affect returns through stock price changes and currency movements. Indian investors benefit from capital growth in US markets and the possible strength of the dollar against the rupee.

Track corporate actions and maintain tax records carefully. ADR investments might need tax reporting both in India and overseas.

Managing ADR investments

Learn about tracking ADR performance, handling corporate actions, and understanding tax reporting requirements for global portfolio management.

Proper portfolio monitoring and management are essential for the success of your ADR investments. These guidelines will help you manage your international investments effectively.

Tracking ADR performance

Reliable financial platforms with immediate data updates provide the best way to monitor your ADR investments. You should track both ADR price movements and their underlying shares in home markets. Your portfolio management needs regular performance updates because target percentage deviations might indicate rebalancing requirements.

Handling corporate actions

Your ADR holdings can change with corporate actions like dividends, mergers, or stock splits. Your depositary bank sends notifications about these events. You might need to respond to:

Voluntary corporate actions like equity tenders or rights offers
Mandatory events such as stock splits or mergers
Name or symbol changes

Tax reporting requirements

Knowledge of tax obligations is vital for ADR investors. Here are the key points:

The US government takes a 25% withholding tax on dividends
Holdings over 24 months face 12.5% long-term capital gains tax plus applicable surcharge
Your income slab rate applies to short-term gains added to total income
The India-US Double Taxation Avoidance Agreement lets you claim foreign tax credits

To claim US tax credits, you must submit Form 67 with your Income Tax Return. For currency conversion, tax calculations require the SBI TT buying rate from the last day of the previous month.

Looking ahead

ADRs are a great way to get practical experience and vary your investment portfolio beyond Indian markets. These investment tools let you access major global companies while trading in US dollars. You'll also benefit from US market regulations and settlement systems.

Your ADR investment success relies on understanding their mechanisms, especially price relationships and corporate actions. Smart decisions come from closely watching both ADR and underlying share performance. The strategy should account for currency fluctuations and tax requirements in both countries.

Proper groundwork is essential for a successful ADR investment experience. Focus on sponsored ADRs from major exchanges. Keep detailed records of taxes and stay updated about corporate actions. With the right knowledge, ADRs can become a powerful tool in your global investment strategy.

Frequently asked questions about American Depository Receipts in the stock market

1) What is an American depositary receipt?

An American depositary receipt is a negotiable security representing shares of a foreign company traded on US financial markets. This certificate allows you to own shares of overseas companies while trading in US dollars. US depositary banks issue these receipts and hold the actual shares in custody.

2) What is an example of an American depositary receipt in India?

ICICI Bank's ADR stands as one of India's most prominent examples. Buying ICICI Bank's ADR on the NYSE means you're investing in the same company that trades in India through a US-listed security. Other examples include:

HDFC Bank
Infosys
MakeMyTrip
SIFY Technologies

3) What is ADR in the Indian stock market?

ADRs act as a bridge between Indian and international markets. They give Indian companies access to US financial markets and help raise funds if they meet strict regulatory requirements. Indian investors can use ADRs to:

Invest in Indian companies through US markets
Benefit from dollar appreciation against the rupee
Access a more liquid trading environment

Your ADR investments are regulated by both the Indian and US markets. The dividends are in US dollars, and you must comply with the RBI's regulations for outward remittances.

4) How can I analyse Indian stocks before investing in their ADRs?

When analysing Indian stocks for ADR investment, research the company's performance over the past five years. Look at key metrics such as earnings per share, price-to-book ratio, price-to-earnings ratio, dividend yield, and return on equity to assess the company's financial health and growth potential.

5) What are the advantages of investing in ADRs over common stocks?

ADRs offer the benefit of investing in foreign companies while trading in US dollars on US exchanges. They provide easier access to international markets, eliminate direct currency conversion hassles, and often have better liquidity than trading the underlying shares on their home exchanges.

6) What tax considerations should Indian investors be aware of when investing in ADRs?

Indian investors in ADRs need to consider tax implications in both India and the US. Dividends from ADRs are subject to a 25% US withholding tax. Long-term capital gains (holdings over 24 months) are taxed at 12.5% plus applicable surcharge in India. It's important to be aware of the India-US Double Taxation Avoidance Agreement and the process for claiming foreign tax credits.

Disclaimer: This article is for informational purposes only and does not constitute financial advice. Investing in ADRs involves risks, including currency fluctuations and geopolitical factors. Always conduct thorough research and consult with a qualified financial advisor before making investment decisions. Market conditions and regulations may change, potentially affecting the information provided.

Contributed by Denila Lobo

Denila is a content writer at Winvesta. She crafts clear, concise content on international payments, helping freelancers and businesses easily navigate global financial solutions.

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