Currency Impact on ADR’s

In a previous post I calculated the impact of currency change on a specific ADR, Diageo, the UK spirits company. To do this, I looked at the price in US dollars on the US exchange (in this case the NYSE) and the price of the “underlying” stock on its resident exchange, in this case in Pounds on the London Stock Exchange (LSE). In the case of this stock, the ADR (which we own in the US) decreased in US dollar terms (what we really care about) by 25%, while the “underlying” stock on the LSE increased in value by 4%, for a “performance gap” of about 29%. The UK Pound dropped by about 27% during this period against the US dollar, which accounts for this difference.

Due to the large impact of currency moves on ADR’s, I am going to attempt to track this going forward on the spreadsheets that I use for each portfolio. For each ADR I buy I will do the following:

– track the price of the ADR on the US exchange at the time I bought it (already doing this)
– track the price of the ADR on its “home” exchange at the same date (this is new)
– track the ratio of US Dollars to the relevant foreign currency (in the case of Diageo, it is dollar vs. Pound relationship) on that same date
– then for each update I will track how the performance of the “underlying” stock is on its home exchange (in the case of Diageo, up 4%)
– I will track the performance of the US dollar vs. the foreign currency
– Then I will determine the portion of the gap tied to foreign currency moves, which will likely be the total performance difference between the ADR and the underlying value on the home exchange

In this post, I describe the process that I use to track stock performance and overall portfolio performance on each of my accounts (up to 5 now). The process of tracking performance is MUCH more complicated and tedious than you might think, since I am trying to track a lot of items that your brokerage statement either doesn’t want you to know or hasn’t thought through the process of giving it to you in a useful format. For 99% of the population out there (maybe even a higher percentage) taking apart the brokerage statement in detail and looking at the component pieces of return will teach you something that you don’t know. While the quality of the analytics provided by outside vendors is increasing, it is still not simple to track performance, pull out expenses, the portion of return due to dividends, etc… And I would be willing to bet that the average investor doesn’t know the portion of their portfolio’s return due to currency moves between the parent and the underlying exchange for ADR’s, for instance.

For those that are expert investors there are other impacts of currency moves WITHIN the stock price that aren’t simple to show like the Diageo example, above. For instance, if a company produces goods in a country with a strong currency and sells them in a country with a weak currency, that company’s profit will be impacted negatively, which will show up in their profit and loss statement, and impact the stock value. To avoid this impact many companies try to “source” production in the same country where it is sold, if that is possible. Companies can also “hedge” by purchasing contracts which, for the cost of the contract, will make the currency impact go away, and to make it more complex many companies only partially hedge. For the purpose of this analysis I am simplifying this away because it is already captured within the existing stock price valuation and future prospects.

I will add this analysis to the stocks that are ADR’s in the portfolio and get this for the update needed for “stock selection season”, which is coming up in late August before the kids / now some are adults go back to school / college for the year.

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