What Is a Tracking Stock?
A tracking stock is a stock issued by a parent company that tracks the financial performance of a particular division. Tracking stocks trade in the open market separately from the parent company's stock.
Tracking stocks are also known as targeted stocks.
- A tracking stock is a type of security issued by a parent company to represent a specific division of the business.
- A company's tracking stock will trade in the open market independent of the parent stock.
- The tracking stock's profits and losses are connected only to the division it tracks, rather than the overall company.
- Companies can issue tracking stocks to raise money from the new issuance of equity, and to give investors the chance to specialize their investment in the company by only investing in a specific division.
- However, tracking stocks carry the same risk as any other stock and may give investors less power, as they don't typically include shareholder voting rights.
Understanding Tracking Stocks
When a parent company issues a tracking stock, all revenues and expenses of the applicable division are separated from the parent company's financial statements and bound only to the tracking stock. The performance of the tracking stock is tied to the financial performance of the division it follows.
If the division is doing well, the tracking stock will rise even if the overall company is performing poorly. Conversely, if the division is performing poorly, the tracking stock will likely fall even if the overall company is doing well.
Companies might issue tracking stocks to separate a division that doesn't fit in with the overall company such as a software developer division that's part of a parent manufacturer. Companies also separate a subsidiary's high-growth division from a larger parent company that is experiencing losses. However, the parent company and its shareholders still control the operations of the subsidiary.
Tracking stocks are registered similarly to common stocks per the regulations enforced by the U.S. Securities and Exchange Commission (SEC). The issuance and reporting are essentially the same as they are for any new common shares. Companies include a separate section for the tracking stock and the financials of the underlying division in their financial reports.
Tracking stocks were more frequently made use of in the late 1990s technology boom than they are currently, although some companies still issue them today.
Tracking Stocks Benefits and Risks for Investors
Tracking stocks allow investors the opportunity to invest in a particular portion of a larger, parent business. The stock of a parent company that is well-established might not fluctuate too much particularly if it has multiple divisions across various industries. So, tracking stocks can help give investors access to the most profitable parts of a company.
If the division is a new up and coming technology, for example, investors can realize investment gains from its explosive growth. Those gains might not be possible by holding the parent company's stock since the performance of the other divisions could muddy the performance of the technology division. Conversely, prices of tracking stocks for a division that's not performing well or not living up to expectations might decline even if the overall company is on solid footing.
Investors might receive dividends based on the performance of the division regardless of the overall performance of the business as a whole. A dividend is a financial payment, returned to shareholders by companies. However, not all tracking stocks pay dividends. Tracking stocks also allow investors to participate in the business segments that appeal most to them and best fit their risk tolerance.
If a parent company experiences financial hardship and goes into bankruptcy, investors holding tracking stocks will not have a claim on the assets of the division or those of the parent company. Investors need to be mindful of the risks involved in buying a tracking stock when the parent company is struggling or not well established.
Investors holding tracking stocks do not have all of the same rights as common stockholders. Common stockholders can vote but tracking stocks usually have no voting rights, or at best, limited voting rights at the shareholder meetings.
Tracking Stocks Benefits and Risks for Companies
Companies that issue tracking stocks raise funds from any new issuance of equity. The funds can be used to invest in the division and buy assets or new technologies to accelerating growth.
Companies can gauge investor interest in specific segments of the business through the associated activity of each tracking stock. For example, a large-scale telecommunications company may choose to use tracking stocks to separate the activities of their wireless, or cellular division from its landline services. Investor interest in each division can be measured based on the activities of each of the tracking stocks.
Tracking stocks also eliminate the need for the company to create a separate business or legal entity to separate the associated activities. This separation removes the need for the creation of additional management teams and shareholders as would occur when establishing a new legal entity, such as with the creation of a spinoff.
Companies that issue tracking stocks might be parsing out the best parts of their company. If the parent company and the parent stock price are underperforming, investors holding shares might lose interest and sell. By separating out the outperforming divisions, it might cast a light on how poorly the parent company is doing.
Tracking stocks give investors access to a profitable division of a company.
The performance of tracking stocks comes only from the division and not from the parent company as a whole.
New issuance of tracking stocks provides companies with capital to fund growth.
Investors might receive tracking stock dividends regardless of the overall performance of the parent company.
Investors can lose money on tracking stocks if the division performs poorly even if the parent company does well.
Tracking stocks may be issued by companies that are struggling.
Holders of tracking stocks don't have voting rights at shareholder meetings.
Investors don't have a claim on the parent company's assets in the event of bankruptcy.
Real-World Example of a Tracking Stock
Let's say as an example, Apple Inc. (AAPL) has decided to issue a tracking stock for their streaming news and movie service. The remaining products such as iPhones will remain under the parent company.
The tracking stock's performance will be solely based on the profitability of the streaming business. Apple issues 1 million shares of the tracking stock at $50 per share generating US$50 million in new capital for the division.
Following the issuance, Amazon.com and Netflix announce a partnership to issue streaming services, which is in direct competition to Apple. As a result, Apple's streaming division struggles and the tracking stock falls to $30 per share. However, Apple's iPhone sales are doing well as is the parent company's stock.
Investors who buy tracking stocks can realize gains from the underlying division's performance, but the stocks also have the same risks as any stock in the market. Many internal and external factors can impact the success of a tracking stock including macroeconomic conditions, the competitive landscape, poor management, and new technologies.