The 1 Thing You Need to Know Before Buying Foreign Oil Stocks

As our era of intense globalization rages on, more and more companies are looking to reach investors outside of their own borders. In 2013, an estimated $1.06 trillion was held in global depositary receipts, allowing companies to trade their shares on a multitude of exchanges worldwide.

Despite this opportunity, buying shares of foreign companies through American Depositary Receipts, or ADRs, might not make sense for every U.S. investor. Today we're taking a quick look at ADRs in the energy space to determine whether or not they belong in our portfolios.

Source: Flickr/"Oil rigs, North Sea oil, Scotland, UK" by Berardo62

What are ADRs
Any energy investor who has perused shares of big oil companies on the New York Stock Exchange has likely come across a few ADRs. An ADR is essentially a certificate issued by an American bank that represents a certain number of shares of a foreign company, for example Brazil's Petrobras (PBR 5.71%) or the United Kingdom's BP (BP 1.58%).

ADRs and the number of ordinary shares they represent can vary widely from company to company. For example, one ADR for Petrobras represents two ordinary shares in the company, but one ADR for BP represents six ordinary shares in the company. Before you buy in, make sure you look up your company on one of two ADR-specific websites operated by JP Morgan or BNY Mellon so you know exactly what you're purchasing.

Which energy stocks are ADRs
According to adr.com, the JP Morgan site, there are 185 companies in the "energy & minerals" sector using depositary receipts of some kind worldwide. When we narrow that list down to ADRs on the New York Stock Exchange, we get a much smaller list of 18 stocks, including some of the familiar names listed below:

Source: adr.com

You can see that the New York Stock Exchange is the exchange of choice for these big name energy players (there are none listed on the Nasdaq). You'll also notice that the ratio of ADRs to ordinary shares does truly vary widely by company.

What else do I need to know?
By and large, buying an ADR is a straightforward process, virtually the same as purchasing a domestic stock. Once you own an ADR, however, you will notice there is a big difference if and when dividend time rolls around.

Each foreign country has a different way of handling taxes on dividends. Some dividend tax withholding rates can be as high as 35% and as low as 0%. The motherland will take its share before the dividend hits your account, where it will then be subject to Uncle Sam's take, depending on what type of account you have it in. Now, you can file for a foreign tax credit, but it will only cover withholding up to 15%. So if your stock is subject to foreign withholding taxes of 30%, you still lose 15% when it's all said and done. Therefore, it is crucial to know what the withholding rate will be for your particular stock before you make it the cornerstone of your dividend investment strategy. You can look up withholding rates here.

Bottom line
Buying foreign-based companies can add a new dimension to your portfolio, but they do require a little bit more work in the beginning, especially when it comes to dividend taxes, making it more important than ever to know exactly what you're getting when it comes to these foreign stocks.