ADRs basically serve two purposes. First, they give foreign companies access to U.S. financial markets. Second, they give U.S. investors an easy way to gain exposure to foreign companies.
Out of the nearly 8,850 names in the Reuters.com stock universe, 508 are ADRs. Yet, only 49 ADRs recently cleared the Reuters Select stock screens. (Click here for an Excel sheet comparing these ADRs.)
We focused on companies that have been growing relatively quickly. Given the length of time of the current global economic expansion, we filtered for companies that have outperformed their respective industries on the basis of revenue and earnings growth over the last five years. This shortened our list to 15 names.
While growth rates are important, we also wanted to highlight companies where management is effectively using available capital resources. For this, we turned to return on investment [ROI], which is calculated as net income divided by shareholder equity, long-term debt, and all other long-term liabilities. Again, we looked for companies that have outperformed their industry averages over the last five years. But, we also wanted companies that have been growing relatively well more recently. As such, we also honed in on companies that have better-than-average ROI in the trailing 12-month [TTM] period.
Further, we wanted companies where ROI performance has improved lately, so we also filtered for companies where the magnitude of their relative advantage over the industry norm was greater in the TTM span than over the last five years. This left us with seven names, including Telecomunicacoes de Sao Paulo.
Telecomunicacoes de Sao Paulo's solid ROI results in the TTM and five-year periods also enabled it to land on the Strong Return on Investment stock screen. The screen requires that a company's ROI must be at least 20 percent better than the industry average over both of these time periods. The screen also looks for improvement over time, further requiring that a company's TTM reading must be at least 20 percent better than its own five-year average.
A company's ROI can receive a boost from profit-margin improvement, as more revenue gains make larger contributions to net income. Given Telecomunicacoes de Sao Paulo's significant advantage in terms of ROI over the TTM and five-year periods, it is not surprising to find that the company also has considerably wider profit margins, which have improved in the TTM span from their five-year norm. The company's operating margins eclipse the industry mean sufficiently for Telecomunicacoes de Sao Paulo to also land on the screen for Strong Operating Margins.
The Strong Operating Margins screen seeks companies where the TTM and five-year operating margins are wider than the industry figures, and it also identifies companies that have improved over time. The screen accomplishes this last task by filtering for companies where the TTM operating margin is at least 25 percent above its own five-year figure. As indicated below, Telecomunicacoes de Sao Paulo's TTM operating margin is about 35 percent better than its longer-term average.
In our search for ADRs, we were also interested in valuation. We filtered for the companies that have price to earnings [P/E] and P/Sales ratios that are south of their industry averages. Here, we were left with two telecommunications companies, South Africa's Telkom SA Ltd. (TKG) and Brazil's Telecomunicacoes de Sao Paulo SA (TSP).
Those valuation metrics are based on TTM performance of both earnings per share [EPS] and sales. Since stocks are at least theoretically valued on the basis of future performance, it is often helpful to also examine the current price relative to analyst expectations for future EPS for both this year and the next. This yields the forward P/E ratios. By themselves, the forward P/Es don't tell us much. It's the PEG ratio we're after and we get it by dividing the forward P/E by the consensus of analyst estimates for a long-term EPS growth rate.
Typically, more conservative investors like to focus on companies with PEG ratios that are below 1.00, but numbers even a bit north of this threshold are generally still reasonable. In looking at Telkom and Telecomunicacoes de Sao Paulo, we found that, at present, no analysts provide earnings estimates to Reuters.com for Telkom. For this reason, we settled on Telecomunicacoes de Sao Paulo.
Based on expected EPS of about $2.46 for 2006 and $2.49 for 2007, and a current ADR price of roughly $24.70, Telecomunicacoes de Sao Paulo has forward P/E ratios of approximately 10.0 and 9.9, respectively. With a consensus long-term EPS growth rate of about 6.6 percent, Telecomunicacoes de Sao Paulo has PEG ratios of roughly 1.52 and 1.51.
Trading in ADRs comes with a few caveats investors should keep in mind. Although they trade like U.S. stocks, they are effectively baskets of a foreign company's stock. For example, one company's ADR might be the equivalent of 10 shares of that company's stock in its home country, or it might be the equivalent of only half a share. And, of course, one ADR could equal one share. It is also important to keep in mind that ADRs expose investors to the same types of additional political, economic and currency risks that are present in foreign investing.
Disclosure: At the time of publication, Erik Dellith did not directly own shares of any company mentioned in this article. He may be an owner, albeit indirectly, as an investor in a mutual fund or an Exchange Traded Fund.
Note: This is independent investment and analysis from the Reuters.com investment channel, and is not connected with Reuters News. The opinions and views expressed herein are those of the author and are not endorsed by Reuters.com.