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Weak Dollar Bedevils ADRs

What was once a safe hedge against the dollar's decline has become a more complicated play.

Hedging against the weak dollar isn't as easy as it looks.

In recent months, analysts have advised investors to purchase American depositary receipts in order to diversify their portfolios and profit from a slide in the dollar. But anyone who owns ADRs of the German software maker


(SAP) - Get SAP SE ADS Report

knows there can be a downside to the strategy.

On Tuesday, SAP reported a 3% drop in quarterly software revenue, citing, among other things, a weaker dollar. Excluding currency effects, the firm said sales would have climbed 4%, but the stock still fell sharply.

ADRs typically appreciate when the dollar weakens, to reflect the price in the local market. The price of an ADR is the price of the share of stock in its foreign currency multiplied by the dollar value of the foreign currency.

For example,

Deutsche Telekom

(DT) - Get Dynatrace Inc. Report

is currently trading at 15.67 euro in Germany, and the euro trades at $1.258. Because one ADR is equal to one share of the underlying stock in this case, the ADR should sell for $19.71, because 15.67 multiplied by 1.258 is $19.71. Indeed, Deutsche Bank's ADRs trade right around this level.

If the euro rises to $1.30, however, the ADR would climb to $20.37, because 1.3 multiplied by 15.67 is $20.37.

Still, as SAP demonstrated, investing in ADRs isn't an ideal hedge. This is because many European and Asian companies tend to export their wares to the U.S. So when the dollar weakens, foreign goods become more expensive to U.S consumers, and demand tends to fall. In fact, the trade deficit narrowed to $38 billion in November from October's revised reading of $41.6 billion, thanks to a decline in imports.

Many foreign companies also sell their products in U.S. dollars, so currency translations can be unfavorable.

One ADR that may be at risk going forward is


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(SI) - Get Silvergate Capital Corporation Class A Report

, according to strategists from Goldman Sachs. "We believe the main risk to our positive view

on Siemens comes from the rising euro," the firm said in a report last month. Analyst Charles Burrows said the company buys many of its raw materials in U.S. dollars, and he noted that for every 3% move in the euro/dollar rate, Siemens' earnings move by 1%.

Analysts also worry that auto companies such as



could see sales decline because the U.S. is a key market.

Finnish phone maker


(NOK) - Get Nokia Corporation Sponsored American Depositary Shares Report

issued a positive preannouncement recently, but analysts say the falling greenback continues to be a thorn in the firm's side. Late last year, Nokia trimmed its earnings guidance, citing the effects of a weaker dollar on exchange rates.

Meanwhile, some analysts say British drugmaker


(GSK) - Get GSK plc American Depositary Shares (Each representing two) Report

could suffer because it generates more than half of its sales in the U.S market.

"Everything you gain on the currency, you might lose on the underlying stock," noted Ivka Kalus-Bystricky, a portfolio manager at Baring Asset Management.

Still, she added that some ADRs have been unduly punished. At SAP, for example, there is no fundamental problem weighing down the company, and the analyst believes investors should have ignored the currency translation issues. "If you liked the company before it fell, you should really like it now," she said.

Although SAP declined 5% on Tuesday, the ADRs have gained 75% over the past year, compared with a 46% rise for the underlying shares. Kalus-Bystricky also noted that many companies have hedging strategies in place to smooth out currency fluctuations.

Judging by the recent performance of ADRs, it would seem that the net effect of a weaker dollar is positive overall. The Bank of New York's index of leading European ADRs has risen 34% over the past year, and its index of Asian ADRs has gained 35%. The dollar has fallen more than 16% against the euro and 11% vs. the yen. The dollar also has fallen sharply against the British pound over the past year.

If you expect the dollar to continue weakening this year, Merrill Lynch quantitative strategist Savita Subramanian said, "investing in ADRs may

still be a good currency play."