Tracking Stock Definition, Examples

Tracking stocks are a type of investment that represents ownership in a specific division or subsidiary of a larger company. The value of the tracking stock depends on the performance of that specific division, not the whole company. They can be helpful for investors who want to focus on specific areas of a company, but they can also be riskier than regular stocks. It’s important to research and understand the potential risks involved in any investment before making a decision. In this article, we will cover everything you need to know about Tracking Stock.

What is a tracking stock?

A tracking stock, also sometimes called a targeted stock, is a specialised equity offering that “tracks” or depends on the financial performance of a specific business segment or subsidiary. The issuing parent company does this in order to unlock value for shareholders or utilise the subsidiary’s assets without having to spin it off into a fully independent company.

For example, say Company XYZ has four different business divisions: A, B, C and D. Division B has been wildly successful lately compared to XYZ’s other units. By issuing a tracking stock solely for Division B, Company XYZ allows investors to buy shares linked only to Division B’s financials. So while tracking stockholders are still part-owners of Company XYZ, their investment is isolated from underperforming divisions A, C and D.

This gives Company XYZ a way to raise funds specifically for high-growth Division B without diluting ownership of the entire company. The division can use money from its tracking stock offering to expand operations, pay down unit-level debt, etc.

Reasons companies issue tracking stock

There are a few key reasons parent companies take this route:

1. Tracking stock helps companies highlight a successful part of their business. 
2. It motivates managers and employees to work harder and can help retain talent. 
3. Money from selling tracking stock goes directly to that successful part of the business. This can help it grow and innovate. 
4. Tracking stock can also help companies spin-off that part of the business into a separate company.

Benefits of tracking stocks to investors

In addition to the parent company advantages above, tracking stocks also offers certain advantages to investors beyond traditional stock ownership:

1. Target Exposure to High-Growth Segment: Invest in a promising new subsidiary instead of older parts of the company. This type of investment is tied to the new subsidiary’s profits.
   
2. Granular Financial Data: Tracking stock investors receive regular income reports that offer transparency into business segment profitability.
   
3. Focused Strategy: Tracking stock allows a company to split up into different parts and focus on growing each part to create more value for shareholders. 
   
4. Voting Rights on Segment Governance: Tracking stock shareholders can vote on policies and leadership changes for the subsidiary unit operations, separate from the corporate parent voting structure.

Tracking stocks risks and downsides

However, tracking stocks also comes with unique structural risks and downsides investors should weigh:

1. No True Ownership of Subsidiary Assets: Tracking stockholders don’t own the assets of a subsidiary company, even though they own a part of its financial performance. The parent company retains full control and ownership of the subsidiary’s assets.
   
2. Exposure to Parent Company Liabilities: Tracking stock measures the performance of a specific business area, but investors can still be liable for debts and legal issues of the parent company. If the larger corporation goes bankrupt, tracking stock values can be lost entirely.
   
3. Conflicts of Interest: Parent companies have to balance the needs of multiple divisions, shareholders, and debt holders. But this can conflict with investors who are only interested in one aspect. This can lead to parent companies using resources in ways that hurt investors.
   
4. Tax Implications: Tracking stocks have special tax rules that can put investors at a disadvantage. You may have to pay taxes on a parent company’s profits, even if you only own tracking stocks and not the parent company’s actual stocks. This can happen if there are restrictions on the spin-off of the tracking stocks.

Tracking stocks offers investors profit potential from a subsidiary of a company, but they lack the straightforward ownership and control offered by regular common shares. This indirect exposure also adds complexity.

How to track stocks?

If you decide the pros outweigh the cons and move forward with tracking stocks, monitoring their price activity requires some unique steps:

1. Research the Parent Company – Get fully acquainted with the core business, leadership team and company structure. This establishes critical context.

2. Focus on Division Financials – Pay closest attention to revenue, profitability metrics and growth forecasts specifically for the tracked unit. Compare these figures to competitors when possible.

3. Follow Corporate News – Tuning into quarterly earnings calls will shed light on the performance of the subsidiary in particular. Also, take notice when division leaders are appointed. 

4. Watch for Spin-Off Chatter – If the parent company mentions plans to separate the unit down the road, expect shareholder value to rise in anticipation.

5. Use Quote Pages Wisely – When pulling up a tracking stock quote, make sure you have the one actually linked to division performance rather than overall company value.

If you’re considering investing in tracking stocks, there are some important things to keep in mind to increase your chances of success. These tips will help you approach tracking stocks with diligence, even if you have a limited amount of technical knowledge about trading.

Conclusion

While tracking stocks give investors a more targeted approach to profiting from a company’s high-growth business segment, they come with structural disadvantages that require thorough due diligence. Assessing the risks specific to a particular tracking stock’s parent-subsidiary dynamic is vital to determine whether these complex assets warrant inclusion in an investment portfolio.

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