OTC stocks and ADRs explained
Updated
August 28, 2024
OTC ADRs are a gateway for adding international stocks to your portfolio.
Over-the-counter securities (OTCs) are stocks or other assets like commodities and currencies that aren’t listed on a major stock exchange, like the NYSE or NASDAQ.
Instead, OTC stocks are traded directly between two parties, without an intermediary’s involvement.
That means an OTC market is made up of networks of buyers and sellers. There are fewer people involved than on a large exchange, which makes OTC stocks less liquid.
Sometimes, that means it’s harder to buy or sell shares for the price you’re hoping for. And that’s a big reason why investing in OTC stocks is different and typically riskier than investing in those on a formal exchange.
But OTC stocks carry a sliding scale of risk. Any given OTC stock’s level of risk and volatility tends to differ depending on its classification, so they shouldn’t all be painted with the same brush.
In addition to the extra volatility and their lower level of liquidity, most OTC stocks carry extra risk because they are subject to lighter regulatory reporting requirements. Depending on the type of OTC investment, companies might not publish regular financial statements.
Usually, companies in search of an OTC listing won’t have to adhere to nearly as many restrictions and requirements as companies listing on major exchanges, like the London Stock Exchange (LSE), would.
So, OTC stocks often carry higher risks than exchange-traded stocks.
That’s not to say there aren’t large, well-known and highly-established companies that trade OTC as opposed to on a major exchange.
And generally, the idea behind investing in higher-risk assets is that you could end up with an above-average reward. That’s certainly not always the case - whenever you invest, your capital is at risk. Plus, a riskier asset can result in a bigger loss.
Everyone will have their own financial goals and unique circumstances when they invest. These preferences, along with your time horizon, should help you decide on the mix of assets you choose to invest in.
Our resource hub for investing in the stock market can help clarify what that blend of investments might look like. And our guide on how to invest in stocks is a great start if you’re just getting started in your investment journey.
Remember, if you’re still unsure of how to pick your investments, speak to a qualified financial advisor to develop your own investment strategy. OTC stocks may or may not be right for your balanced portfolio.
To figure out whether OTC stocks could be a good investment for you, you’ll want to first understand the different types of OTC investments.
First, it helps to understand how an OTC trading transaction takes place. They can happen through the OTC Markets Group’s electronic trading platform, which matches buyers and sellers. OTC Markets Group also provides the price and liquidity information needed to trade its OTC securities.
The OTC Markets Group platform is segregated into three market tiers. Each of these is separated based on the quality and regularity of a company's reporting information and disclosures.
The three matching platforms are:
We’ll now break down the types of stocks you can expect to find in each of those tiers.
On the OTC stocks ladder, OTCQX stocks are considered the least risky. But it’s all relative. And these companies still have a fairly lax set of qualifications for trading on the OTC Markets platform compared to major exchange-traded stocks.
OTCQX stocks cannot be penny stocks, shell companies, or companies in bankruptcy. Meanwhile, bankrupt companies can actually keep trading their shares if they’re OTCBB or pink sheets.
OTCQX stocks have to trade at a higher share price, and are subject to SEC regulation. So of the three tiers, they likely have a closer regulatory eye following the company’s management team and financials.
OTCQB is considered the mid-tier in the OTC market. Pink Sheets are often shares in new-stage OTC companies, and while OTCQB stocks can be penny shares too, they’re usually slightly less risky.
There are some minimum reporting standards that OTCQB stocks have to adhere to. Companies need to remain current in their reporting, have had a minimum bid price of $0.01 per share at the close of business for the past 30 calendar days, and not be in bankruptcy.
They’ll also undergo an annual verification and management certification process.
OTCQB companies also need to maintain that share price at the close of business at least once every 30 consecutive calendar days.
OTCQB stocks represent shares in companies which can be headquartered anywhere globally. They will include shell companies and penny stocks, so they are in no way guaranteed to be a less risky, let alone better, investment than stocks in the Pink Sheets. Though, these companies will have some stricter reporting and trading requirements.
Pink Sheet listings are shares in companies that don’t meet the listing requirements for major stock exchanges. Most of them are ‘penny stocks’, which means they tend to be a higher investment risk than the other types of OTC stocks.
If you’re expecting all of these stocks to trade around one penny, contrary to their name, penny stocks can cost you more than just one bronze coin.
A penny stock is a share that trades for less than £1 in the UK or less than $5 in the US.
They’re typically shares of companies that have market caps below £100m in the UK or below $300m in the US.
On the one hand, smaller companies can be hidden gems if you know where to look and what to look for. Size isn’t everything, after all.
On the other hand, Pink Sheet stocks are more volatile, which adds an extra layer of risk.
The main reason a penny share would choose to trade OTC rather than on the NASDAQ or NYSE is that it won’t have to adhere to the stricter regulatory standards required of bigger exchanges.
This decision could be a matter of a small company preferring not to undergo the costly regulatory burden of fulfilling the trading or capital requirements. Given size and capacity restraints, some companies may even be incapable of meeting those requirements altogether.
While the former might be a red flag, there’s no real way of knowing whether that’s the case for the company you’re investing in. You can’t always be certain from the outset why a company chooses to list OTC, which is yet another reason doing your own research before jumping into an investment is key.
If you’re allured by the ‘cheap’ price of an OTC Pink Sheet stock, there might very well be a reason that the price tag is so small. If you’re buying junk, then who cares if the price is low?
While Pink Sheet listings do still have a few requirements, they don’t have to adhere to a certain share price, unlike less risky stocks on OTC Markets’ OTCQB and OTCQX platform tiers.
Then there are American Depository Receipts (ADRs). ADRs aren’t another tier on the OTC Markets Platform, but they can still trade OTC.
They represent a foreign company’s stock with a listing on a US exchange. That means the stock trades in USD, and if it pays dividends, those will be paid in USD too, no matter where the company is based.
Not all ADRs are OTC stocks. Some ADRs will list on the NASDAQ or NYSE, for example.
But OTC ADRs, compared to other OTC stocks, tend to be lower risk because they often represent shares in large, global companies. That means their shares are more liquid than the smaller companies that tend to list on other OTC Markets platforms.
On the Freetrade app, you can currently find 20 OTC ADRs.
Source: Freetrade, as of 7 October, 2022.
You’ll probably recognise a few of these stocks as household names. By investing in them through ADRs as opposed to their original listing, you will get access to the stock without needing to invest in its home-market exchange.
Take Nintendo for example. The OG video game and console maker is headquartered in Japan. Founded in 1889, it started as a playing cards maker, later Switch-ing things up (pun very much intended) with software and hardware.
If you wanted to buy shares in Nintendo, you would need access to the Tokyo or Osaka stock market. You’d also need Japanese yen on hand. And if Nintendo were to pay dividends, then you’d receive these in yen too.
That is, unless you invest in Nintendo’s ADR (NTDOY), which trades in USD.
An ADR won’t always represent one whole share. Sometimes it reflects several shares, or a fraction of a share, in the foreign company it’s representing. In NTDOY’s case, one NTDOY ADR is one-eighth of a Nintendo share traded on a Japanese exchange.
So if you wanted one ordinary Nintendo share, you would need eight NTDOY shares.
As a US investor, you’d need to consider the exchange rate of USD to JPY.
Here’s an example of why that matters.
If one US dollar was equal to 145 Japanese yen at the time of your trade, and then you sold it when the US dollar was equal to 110 Japanese dollars, all else equal, the US dollar is less strong. This could increase your loss on the investment.
For a UK investor investing in ADRs, there is the added element of figuring out how the USD to GBP exchange rate will impact your investment.
Tencent long wore the crown of China’s biggest company. Though it’s recently handed it over to liquor company Kweichow Moutai, it still holds the spot for the largest video game firm in the world.
Tencent is headquartered in Shenzhen, China.
The holding company has a plethora of subsidiaries beyond gaming, including social networks and AI tech development.
It was the first Asian company to pass the $500bn market cap mark and ranks among the 10 biggest companies in the world.
All of this is to say Tencent is no small fry, and certainly no penny stock. But it also comes with its own set of investment risks.
Tencent’s shares have been falling since peaking in early 2021. Largely, that’s been a result of growing regulatory pressures in China, which have led to the country’s tech giants getting their market caps shaved down.
It’s crucial that you research the macroeconomic and geopolitical environment of an ADR’s home market. Even though the stock will trade in USD, it’s subject to its HQ regulations. And an unstable home market can often lead to an unstable investment projection.
In China’s case, the nation is currently battling lockdowns which are battering local demand. And Chinese tech firms are up against ongoing regulatory crackdowns, leading to app and web suspensions. The bureaucratic burdens have grown too much to bear for firms like Amazon and Airbnb, which have entirely shut down Chinese operations.
While this could be an opportunity for Tencent to capture that local demand for a range of tech tools, the landscape is still vastly uncertain. Tencent’s certainly not immune to China’s State Administration for Market Regulation (SAMR) policies. And the firm was walloped by 12 accusations of wrongful mergers linked to antitrust regulations.
Tencent would have been fined about $74,600 per case (the maximum under China’s Anti-Monopoly law). And while that’s not a huge pill to swallow for one of the world’s biggest companies, it proves the firm is not protected from the Chinese regulatory bodies cracking the whip.
The above is just a small sampling of some OTC ADRs now available on the Freetrade app.
If, after doing your research, you believe OTC ADRs could be right for your portfolio, here’s how you can start investing.
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