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  • Overseas Investing at Home: Screening for Reasonably Priced ADRs

    by John Bajkowski

    Overseas Investing At Home: Screening For Reasonably Priced ADRs Splash image

    Portfolio diversification among different kinds of assets, industries, and securities is a basic principle of sound investing.

    One tactic to ensure that you are investing in different kinds of securities is to add some degree of exposure abroad—invest internationally.

    Individual investors can easily access the foreign markets via international mutual funds. Direct investment in foreign-traded stocks is difficult and costly for the individual investor.

    However, if you want to invest in individual stocks, an excellent route overseas is to purchase shares of international companies in the form of American depositary receipts (ADRs). A depositary receipt is a negotiable certificate that is issued by a U.S. bank and represents shares of a non-U.S. publicly traded company. They are priced in U.S. dollars and owners avoid many costs associated with direct foreign investment, such as international settlement, global custody, foreign brokerage, currency conversions and multi-currency accounting. Dividends are also paid out in U.S. dollars.

    A screen seeking reasonably priced ADRs is built into Stock Investor Pro, AAII’s fundamental stock screening program and research database. The simple screen looks for companies trading with a low PEG ratio (price-earnings ratio divided by earnings per share growth) and exhibiting strong recent price momentum. The screening criteria used in the program are detailed below.

    ADR Basics

    While the world markets tend to move in the same general direction, individual ADRs are usually highly correlated with their home stock market. Performance of the ADR will mirror very closely that of the underlying stock traded on a foreign exchange. For U.S. dollar-based investors, ADRs are also subject to the same currency risk as the underlying stock in the foreign market when the value of the dollar changes relative to the native currency.

    For example, if the U.S. dollar falls against the Japanese yen, the real return to a U.S. dollar-based investor in a Japanese ADR will be greater than the return to a yen-based investor because of the weaker dollar. The investment priced in yen will purchase more dollars. This currency risk makes the returns on ADRs more volatile.

    TABLE 1. ADR Country Breakdown
    Country ADR Listings
    Country ADR Listings
    United Kingdom 18.5 Spain 1.3
    Japan 8.5 Taiwan 1.2
    France 6.2 Denmark 0.8
    Netherlands 5.6 Finland 0.8
    Brazil 5.2 Greece 0.8
    Mexico 5.2 Luxembourg 0.8
    Germany 4.6 Norway 0.8
    Australia 4.2 Belgium 0.6
    China 3.8 Colombia 0.4
    Hong Kong 3.5 New Zealand 0.4
    Chile 3.1 Philippines 0.4
    Switzerland 3.1 Portugal 0.4
    Ireland 2.3 Venezuela 0.4
    South Africa 2.3 Bermuda 0.2
    Argentina 1.9 Dominican Republic 0.2
    India 1.9 Ghana 0.2
    Italy 1.9 Hungary 0.2
    South Korea 1.9 Indonesia 0.2
    Sweden 1.7 Papua New Guinea 0.2
    Israel 1.5 Peru 0.2
    Russia 1.3 Turkey 0.2
    Singapore 1.3    
    Sournce: AAII Stock Investor Pro / Reuters.

    ADRs are issued by U.S. banks that function as a depositary for the actual shares in the non-U.S. company. Stock Investor Pro currently tracks 528 ADRs, of which 449 are exchange-listed.

    ADRs have generally been represented by the most widely held, actively traded non-U.S. issues, and most are categorized as mid- and large-cap stocks. These types of firms have traditionally become ADRs for two reasons: first, to enhance their image as a world-class stock while increasing company exposure and, second, to satisfy the need for raising equity capital in markets outside of the firm’s home country. Toyota Motor Corporation, Nokia, GlaxoSmithKline, Siemens AG, Barclays PLC, and Sony are just a few examples of prominent ADR issues.

    The 528 ADRs in Stock Investor Pro are spread throughout 43 countries (see Table 1). Thirteen of these countries have only one or two stocks representing their country in the U.S. markets, while other countries have dozens of stocks listed in the U.S. The greatest concentration of ADRs comes from well-developed countries including the United Kingdom, Japan, France, and the Netherlands.


    ADR Quirks

    It is important to understand a few minor quirks that are characteristic of ADRs before performing any quantitative screen.

    Share statistics for ADR companies—including price-earnings ratios, earnings per share growth rates, and shares outstanding—may be difficult to interpret unless you understand the per share conversion ratio and the inconsistent reporting of quarterly financial statements.

    The conversion ratio indicates the number of shares of the underlying foreign security that are equivalent to one ADR share. For example, for an ADR that has a conversion ratio of 10-to-1, a single ADR share represents 10 shares of the underlying foreign stock. This ratio varies from ADR to ADR. BP’s conversion ratio is six, Aventis’ ratio is one and Honda Motor Company’s is one-half.

    When looking at per share data such as the earnings per share figure, you must determine if the figures are presented on the basis of the underlying common stock or the ADR. The issue becomes important when determining price-related ratios such as the price-earnings multiple. ADR share prices need to be converted if the reporting basis is in underlying shares in order to calculate meaningful price ratios. The reporting of this data may vary between data vendors, so be sure to check this before making any assumptions. The per share figures in Stock Investor Pro are presented on a per ADR basis.

    Another consideration is the currency and language in which the annual report and financial statement are presented—native language and currency, or English and dollars. Large multinational firms may prepare their statement in a number of formats and currencies. Mobile TeleSystems OJSC, a mobile phone operator in Russia and the Ukraine, presents its financials in English using dollars.

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    Performance of the ADR Screen

    Figure 1.
    ADR Screen

    The stocks passing the ADR screen have outperformed the S&P 500 large-cap index each of the last four years after two initial years of underperformance (Figure 1).

    The characteristics of the stocks passing the screen are presented in Table 2. The ADR screen in Stock Investor Pro attempts to locate stocks exhibiting growth at a reasonable price (GARP) by employing a criterion that combines a low price-earnings ratio with support from solid historical earnings growth.

    This ratio of the price-earnings ratio to the earnings growth rate (PEG ratio) is often used to measure the balance between value and growth. The PEG ratio provides an indication of how the market values the firm relative to its earnings growth rate. When a firm’s price-earnings ratio is high relative to earnings growth, its price has high expectations built into it relative to what the firm has been able to produce in earnings—and therefore might be overvalued. The flip side—finding undervalued stocks—occurs when the PEG ratio is low and the investor is able to purchase growth at a reasonable price.

    TABLE 2. ADR Screen Portfolio Characteristics
    Portfolio Characteristics ADR
    Price-earnings ratio 15.1 21.2
    Price-to-book-value ratio 2.6 2.2
    EPS growth rate (hist 5yr) 25.90% 6.80%
    EPS growth rate (est 3-5yr) 10.00% 14.00%
    Market cap (million) $5,738 $363
    Relative strength vs. S&P 16.00% 18.00%
    Monthly Observations
    Average no. of passing stocks 17  
    Highest no. of passing stocks 45  
    Lowest no. of passing stocks 6  
    Monthly turnover 42.80%  
    Data as of 4/16/2004.

    A firm with a low price-earnings ratio may not be a bargain if the company has poor earnings growth prospects or is very risky. Firms with higher growth prospects are attractive if you do not pay too much for the earnings. As a general rule, firms with PEG ratios near 1.0 are considered fairly valued, those with lower ratios may be undervalued, and those with higher ratios may be overvalued.

    The median price-earnings ratio of the stocks passing the ADR screen is 15.1, compared to 21.2 for all exchange-listed stocks.

    The historical growth rate of the passing companies is above the exchange-listed median, 25.9% versus 6.8% for all listed stocks. The expected growth rate of 10.0%, is below the exchange-listed stock median of 14.0%. However, only about a quarter of all the exchange-listed ADRs have a long-term earnings growth estimate.

    The median market cap of $5,738 million for the stocks passing the ADR screen is consistent with a portfolio of mid- to large-sized companies. In comparison, the median market cap of all exchange-listed stocks is $363 million.

    The relative strength index of stocks currently passing the ADR screen indicates that they have outperformed the S&P 500 by 16% over the last year—good performance, but not as good as the 18% for the typical exchange-listed stock. The relative strength index measures performance relative to the S&P 500, with positive figures representing performance better than the index.

    On average, 17 companies have passed the ADR screen over the last six years, but during extreme market conditions we have observed as many as 45 stocks passing and as few as six stocks passing.

    Current Passing Companies

    The primary growth-at-a-reasonable-price factor in the ADR screen looks for ADRs with a PEG ratio less than or equal to 1.0, eliminating all ADRs with high PEG ratios. The screen then looks for companies with PEG ratios greater than or equal to 0.2. This minimal level is specified to eliminate companies with extreme price-earnings ratios or growth rates—values that most often prove to be meaningless. The stocks currently passing the ADR screen are listed in Table 3, ranked by historical PEG ratio.

    The median historical PEG ratio for the passing companies is 0.5, compared to 1.3 for the typical exchange-listed company. Teva Pharmaceutical, an Israeli-based pharmaceutical company, has a historical PEG ratio of 0.5, which was calculated by dividing the 26.9 current price-earning ratio by the 55.9% historical earnings growth rate.

    The estimated PEG ratio for Teva is much higher, due primarily to the much lower expected annual earnings growth of 22.0% over the next three to five years. One should look beyond the growth rate and also study the year-by-year figures to help assess the validity and true trend of earnings.

    The current price-earnings ratios for the passing ADRs range from a low of 6.7 for the Spanish utility Endesa S.A., to 61.3 for the Japanese software company Trend Micro.

    Relative Strength Rank

    The relative strength rank figure in Table 3 indicates how a company’s stock price has performed relative to all other stocks in the complete Stock Investor Pro universe. A rank of 50% indicates that the stock’s performance was better than 50% of all stocks. A rank of 75% reflects performance that surpassed 75% of all stocks—or performance that places the stock within the top 25% of the universe. Investors seeking stocks that show price momentum often look for candidates with strong and improving relative strength ranks. The best way to do this is to check both a short-term relative strength figure and the performance over a long-term period. A high 52-week rank coupled with a more recent low figure—say, a low 13-week rank—points to a company whose relative price strength is weakening.

       What It Takes: Stock Investor Pro ADR Screening Criteria
    • The stock must be designated as an American depositary receipt (ADR)
    • The ratio of the current price-earnings ratio to the five-year historical growth rate in earnings per share (PEG ratio) must be less than or equal to one (1.0) and greater than or equal to 0.2
    • The 13-week relative price strength percentage rank is greater than or equal to the 52-week relative strength rank
    • The 13-week relative price strength must rank in the top 50% of the entire universe of stocks

    The relative strength criteria in the ADR screen looks at establishing a strong relative performance group of ADRs, all exhibiting positive price momentum. In this case, the screen requires a 13-week relative strength rank greater than or equal to the 52-week relative strength rank. A final filter requires 13-week relative strength rank figures to be at least 50%.

    Overall, the group has very strong 13-week relative strength ranks. Four stocks—Grupo Elektra, Vimpel-Communications, Stet Hellas Telecomm, and Mobile TeleSystems—have relative strength ranks in the 90s percentile. Sasol Ltd. has the lowest 13-week relative strength rank, 52%.


    Abroad at Home

    Going forward, it is important to consider all of the factors that might affect the performance of a given stock—company, industry, country, and currency factors. ADRs add an additional level of complexity to the stock selection process.

    For certain ADRs, country factors are outweighed by industry factors. Industries that deal with global resources and products such as mining, forestry, oil, chemicals, machinery, and banking, react more to industry factors than country factors. Earnings changes within these industries will be closely matched throughout the world. For example, if you hold shares of U.S. gold mining firms, do not expect significant added international diversification by buying the shares of a foreign gold mining company.

    On the other hand, industries that deal with consumer goods, household durables, real estate, beverages, and even business services tend to react more to internal country developments. These are the areas to look to for international diversification.

    Before making any investment decision, you should gather all pertinent information and understand the investment thoroughly—including its native country and market, in some cases. Also, keep in mind that no one investment technique will be best in all market environments and that the techniques that worked in the past may not be as useful in the future.

    TABLE 3. Stocks Passing the ADR Growth at a Reasonable Price Screen
    Company (Exchange: Ticker) PEG Ratio Current EPS Groth Rel Strength Country Description
    Aracruz Celulose S.A. (N: ARA) 0.2 0.6 24.9 116.9 23.1 70 59 Brazil produces eucalyptus pulp for paper
    Vimpel-Communications (N: VIP) 0.2 0.6 22.0 94.0 26.5 92 83 Russia cell phone serv in Russia
    Statoil ASA (N:STO) 0.2 12.1 56.0 0.0 86 64 Norway Scandinavian oil & gas co.
    Unilever PLC (N: UL) 0.2 3.0 18.6 61 14 UK food, detergent & home prods
    United Utilities PLC (N: UU) 0.2 10.0 49.2 76 13 UK holding co for multi-utility in UK
    Sasol Ltd. (N:SSL) 0.3 0.8 7.8 28.7 15.0 52 49 South Africa liquid fuel, pipeline gas, fertilizers
    Acambis PLC (M: ACAM) 0.3 9.5 31.0 54 42 UK biotech co developing vaccines
    Eidos plc (M:EIDSY) 0.3 10.8 31.4 70 43 UK interactive software & video tech
    Grupo Casa Saba, S.A. (N:SAB) 0.3 7.9 28.2 54 38 Mexico distribs pharmac'l & consumer prods
    TV Azteca, S.A de C.V. (N:TZA) 0.3 13.4 43.4 83 73 Mexico TV co in Mexico; prods TV programs
    Scottish Power UK PLC (N:SPI) 0.4 1.7 9.6 31.4 6.5 69 23 UK elec, gas, telecomm, wastewater servs
    Eni S.p.A. (N:E) 0.4 4.3 10.5 26.3 3.0 75 46 Italy Oil & gas company
    Endesa S.A. (N:ELE) 0.4 6.7 15.0 54 35 Spain Elec; energy resources; indus'l serv
    Stet Hellas Telecomm. S.A. (M: STHLY) 0.4 15.0 35.4 92 79 Greece mobile telecomm serv in Greece
    Swedish Match AB (M:SWMAY) 0.4 17.4 40.4 75 44 Sweden tobacco prods; matches & lighters
    Grupo Elektra S.A. de C.V. (N:EKT) 0.5 0.5 15.9 31.0 20.0 91 88 Mexico retail appliances, electronics, furniture
    POSCO (N:PKX) 0.5 0.5 12.8 26.9 12.1 69 56 South Korea Korean steel producer
    Teva Pharmaceutical (M: TEVA) 0.5 1.1 26.9 55.9 22.0 69 40 Israel devlps & mkts major therapeutic drugs
    E.ON AG (N:EON) 0.5 1.4 9.5 24.8 9.3 73 53 Germany energy, chemicals, & real estate in Germany
    NDS Group PLC (M:NNDS) 0.5 2.5 28.6 76.0 10.0 73 67 UK broadcast control systems
    Norsk Hydro ASA (N: NHY) 0.5 4.8 11.1 21.1 2.5 65 58 Norway natural res for food, energy & materials indus
    De Rigo S.p.A. (N: DER) 0.5 6.4 12.8 25.1 2.0 75 59 Italy designs, mfrs and mkts eyewear
    FEMSA-Fomento Economico (N:FMX) 0.6 0.8 18.6 29.3 15.0 82 42 Mexico beer & soft drink producer in Mexico
    Mobile TeleSystems OJSC (N: MBT) 0.6 0.8 25.0 40.9 18.5 93 86 Russia mobile cell commun serv in Moscow
    Banco Santander-Chile (N: SAN) 0.6 1.7 14.5 22.8 7.5 67 43 Chile retail & commercial banking in S Amer
    A.F.P Provida S.A. (N: PVD) 0.6 11.5 19.1 59 31 Chile pension fund mgmt in Chile
    Grupo Televisa, S.A. (N: TV) 0.7 0.5 20.6 14.8 45.7 67 59 Mexico produces & broadcasts Spanish TV programs
    Signet Group PLD (M: SIGY) 0.7 15.1 21.7 75 59 UK specialty retail jeweler
    Trend Micro Incorporated (M:TMIC) 0.7 61.3 85.0 89 87 Japan antivirus software & mgmt solutions
    Hanson PLC (N:HAN) 0.8 1.1 17.7 -13.7 8.9 61 50 UK international building materials co
    Australia and New Zealand (N: ANZ) 0.8 1.7 12.5 15.7 7.0 54 29 Australia banking & financial servs in Australia & New Z
    BP PLC (N: BP) 0.8 1.8 19.7 25.9 8.3 76 43 UK prods & mkts crude oil & petroleum prods
    TOTAL S.A. (N:TOT) 0.8 2.4 15.3 18.4 6.1 69 47 France oil & gas & specialty chemicals
    Telefonos de Mexico, S.A. (N: TMX) 0.8 2.8 10.9 7.9 3.6 63 24 Mexico telecomm servs in Mexico
    Huaneng Power International (N:HNP) 0.8 19.1 22.4 85 75 China coal-fired power plants in China
    Canon Inc. (N:CAJ) 0.9 1.0 17.5 19.9 17.0 65 45 Japan electronics & precision engineering
    Honda Motor Co., Ltd. (N:HMC) 0.9 1.0 9.2 10.4 10.0 57 43 Japan motorcycles, autos & power prods
    Aventis (ADR) (N: AVE) 0.9 2.3 25.9 24.3 7.5 75 60 France global pharmaceutical co
    Cresud Inc. (M:CRESY) 0.9 23.1 46.8 65 43 Argentina basic agricultural prods in Argentina
    Novo Nordisk A/S (N: NVO) 0.9 20.3 22.5 80 37 Denmark healthcare co specializing in diabetes
    Grupo Aeroportuario Del (N: ASR) 1.0 0.8 24.9 24.0 23.3 65 62 Mexico airports in southeast Mexico
    ICON PLC (M:ICLR) 1.0 1.2 24.0 22.6 20.3 75 62 Ireland contract research for pharmac'l & biotech
    Ansell Limited (M: ANSL) 1.0 21.7 20.3 78 64 Australia synthetic & natural latex products
    Median for Passing Companies 0.5 1.2 15.1 25.9 10.0 70 49  
    Median for All ADRs 1.0 1.5 20.0 0.2 11.8 48 54
    Median for All Exchange Listed Stocks 1.3 1.5 21.2 6.7 14.0 48 50
    Exchange key: N=New York Stock Exchange; M=Nasdaq National Market

    Source: AAII's Stock Investor Pro / Reuters and I/B/E/S. Data as of April 16, 2004.

    John Bajkowski is president of AAII.


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