ADRs add global diversification to your portfolio

American Depositary Receipts, or ADRs, give you benefits. One is global portfolio diversification. It’s tempting to call ADRs American ‘Diversification’ Receipts. They give you industries that Canada lacks or has in short supply. This can let you earn more while reducing your risk. ADRs also let you diversify by currency, since they generate most of their sales and earnings abroad.

ADRs (American Depositary Receipts) have a place in most portfolios. ADRs and U.S. stocks should make up a quarter or so of your stock portfolio, depending upon your circumstances.

We recently reviewed 36 ADRs including companies from Belgium, China, Denmark, Finland, France, Holland, Israel, India, Italy, Japan, Mexico, South Korea, Spain, Sweden, Switzerland, Taiwan and the United Kingdom.

Some of the above are so-called ‘emerging markets’. Such markets hold the potential for faster economic growth. Most have younger populations than the industrial world. This adds to the demand for goods and services now. And in the future, they’ll add to the demand for financial assets.

Buy abroad what you can’t buy here

ADRs let you buy into industries you can’t buy here. For instance, Japan’s Canon Corp. has no Canadian peers. It manufactures photocopiers, printers, cameras and flat-panel display screens globally. Similarly, many of the other ADRs operate in industries with few or no Canadian counterparts.

Even when you buy ADRs in the same industries as North American companies, you can comparison shop to see where you’ll get the better deal, at home or abroad. Compare consumer goods stock Unilever to U.S. Key stock Procter & Gamble, healthcare stock Sanofi to U.S. Key stock Pfizer and so on.

Keep in mind that ADRs protect you from weaker reporting rules in some overseas markets—because they must file their U.S. financial statements in English using U.S. accounting rules.

Our ADRs deliberately exclude natural resources, financial stocks and some utilities. After all, the Canadian market offers lots of resource companies, financial institutions and high-yield utilities (that face no withholding tax but instead benefit from the Canadian dividend tax credit). That’s why our ADRs include more of the manufacturing stocks and consumer stocks that are harder to find in Canada.

One important thing is to consider all your portfolios (including your spouse’s) as one and strike a suitable overall balance. Use ADRs to add manufacturing stocks and consumer stocks to your portfolio and to get the benefits that ADRs can provide.

Only six of 36 ADRs passed our screens

To come up with ‘buys’ from our list of 36 ADRs, we use four ‘screens’ to exclude companies with one or more drawbacks.

The first screen is the forward price-to-earnings, or P/E, ratios. We put holds on ADRs with P/E ratios of 20 times or more. That’s because if much goes wrong, the P/E can shrink and hurt investors.

Such holds include: ABB, Anheuser-Busch InBev, Alibaba Group, America Movil, Cemex, Ctrip.com International, Kyocera, Luxottica, Melco Crown Entertainment, New Oriental Education, News Corp., Qiagen, Sony, Unilever and Vodafone Group.

A second screen is profits. We put holds on ADRs that are expected to lose money in 2016. But all the ADRs are expected to earn profits this year.

A third screen is the earnings trend. We put holds on ADRs expected to earn less money in 2016. These include ABB, Anheuser-Busch InBev, America Movil, Astra Zeneca, British American Tobacco, Canon, Ericsson Telephone, Korea Electric Power, Kyocera, Luxottica, Nokia, Novartis, Sony, Telefonica, Teva Pharmaceutical, Toyota Motor and Vodafone Group.

Just remember that the U.S. dollar rose against most other currencies until recently. This has likely reduced the dollar value of ADR earnings.

A fourth screen is excessive debt. We define this as a net debt-to-equity ratio of over one time. These include America Movil, British American Tobacco, Cemex, Diageo, GlaxoSmithKline and Telefonica.

Companies free of these drawbacks are current ‘buys’. These include only six of the 36 ADRs that we regularly follow. They are BT Group (NYSE—BT), Honda Motor (NYSE—HMC), Infosys Technologies (NASDAQ—INFY), Philips (Koninklijne) (NYSE—PHG), Posco (NYSE—PKX) and Sanofi (NYSE—SNY).

Keep in mind that Honda Motor and Posco, pay no dividends. On the other hand, foreign investments usually assess withholding taxes—which reduces the size of your dividends.

 

The Investment Reporter, MPL Communications Inc.
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