Tracking Stock: Definition, Benefits, Risks, and Example

Overview

Have you ever come across a stock that looks like it belongs to a company but moves differently, priced differently, and focuses on a specific subsidiary? 

Also known as tracking stocks, these are bought and sold at relevant stock exchanges, and issued by the parent company. But what differs them from a regular stock is, instead of representing the overall performance of the company, it speaks of the specific division or sector’s financial performance.

But why do companies do them and how do they really?

To know more, you need to dive deeper into the technicalities of tracking stocks. Let’s unroll this e-paper without further ado.

What is Tracking Stocks

Think of it this way, instead of putting your whole candy box out, you put out a sample and observe the reaction to evaluate its true value. Sounds like a good strategy right?

Similarly tracking stocks are like regular stocks – issued by the same company and on a relevant stock exchange. But like putting out one sample, they issue a specific stock that measures performance of a specific division or segment of the company, rather than going all in. 

In technical terms, it is a special equity, issued by the same parent company, but analyzes financial performance of a specific division or sector of the company. 

Although the parent company’s stock and tracking stock can be open in the same market separately. Often large or diversified companies typically undergo this procedure when they figure out that a specific division of their company holds more financial potential than the overall parent company. 

Reasons Companies Issue Tracking Stocks

By understanding the reason, traders can understand the chronology and get one step closer to their investment. So here are listed few key components that a parent companies undertake before making a decision on releasing tracking stocks:

• Tracking stocks allows companies to raise funds for the most performing division or even highlight its success among investors. 

• Via tracking stocks, they can encourage their employees to perform with more enthusiasm, maintaining their talent within the organization. 

• The raised funds help in the advancement of specific divisions and aid the business expansion. 

• In a longer viewpoint, it can also assist companies in spin-off specific divisions or sectors of business and run as an independent body. 

Example of Tracking Stock

Without example, a concept is based on just theories, understood all but practical nothing. One of the examples of a major company that issued a tracking stock is Alphabet Inc, which is the parent company of Google. The organization released a new class of stock – “Class C” shares” in 2015. These shares were tracking stocks designed to track the overall performance of Google’s core internet business. The company segregates “Class C” shares from their existing ‘Class A’ and ‘Class B’ shares, which represent ownership in the entire company. 

By creating these “Class C” tracking shares, Alphabet was able to bring attention to Google’s core internet business, offering investors an opportunity to invest in the business without entering the complete Alphabet trade as a whole. It also allowed Alphabet to raise funds for its core internet business without merging the capital with the whole company. It also helped investors get a way to invest in their favorite divisions and contribute to making their investment as one of the most valuable technology companies. 

Benefits and Limitation of Tracking Stocks

What’s more important than getting to a concept – knowing the merits and demerits. Because you know what they say, knowledge makes the experts and half knowledge ruins the expertise. So let’s get familiarize with both sides of the coin:

Benefits of Investors

Investors get an opportunity to invest in a specific portion of a business which increases the potential of return. Investors can access specific business segments for investment, such as dividend-paying divisions or high-growth departments. Besides, tracking stocks minimize the risk potential and promotes greater transparency among specific business units. 

Benefits of Companies

The major benefit or can say motive of tracking stocks is to raise capital for specific parts of a business. For instance, Apple for iCloud Storage services. It can help with more accurate and increased valuation. Despite this, companies can encourage employees with incentives and attract investors for greater investments.

But here, let’s take a good look at the table to know the perks in more simplified way:

Perks For Investors	Perks For Companies
Lets investors invest in specific parts of a company	Helps companies get money for specific parts of their business
Helps investors spread their investments	Can help companies make money from parts that aren’t doing well
Greater transparency and reduced risk	Can attract investors who like certain parts of the business
Diversification of portfolio	Improved market perception and employee incentives

Limitations of Investors 

What makes it a not-so-good choice is that it adds complexity to an investor’s portfolio, especially when they have multiple tracking stocks. As investors own limited influence on tracking stocks, it doesn’t offer any voting rights or cause directional impact. If the division doesn’t work well or face market adversaries, it would directly affect the worth of your investment. Not only this, dividend payment may not remain specific, leading to income uncertainty among investors. 

Limitations of Companies

Although tracking stocks is a risky idea if the company as a whole doesn’t do well, if issued multiple tracking stocks, it can also cause an administrative burden for companies. What next, no uno reverse. Yes, if the company once issued the stocks and later changed its mind due to whatever reason (loss of investor interest etc.), there is no turning back. In addition, issuance of tracking stocks may lead to conflicts of interest among different divisions too, especially ones with the same goals or vision. 

Here now let’s take a look at the setbacks in the picture while trading tracking stocks for both companies and investors in simplified way:

Limitations For Investors	Limitations For Companies
Can be hard to know how much it’s worth	Can be risky if a part of the business doesn’t do well
If a part of the business doesn’t do well, the investment can lose value	Can be hard to know how much the parts are worth
Might not give the same voting rights as regular stock	Might not give the flexibility to play reverse

How to Scan Tracking Stocks

Once you understand the basics of tracking stocks, the next step is to shortlist good-performing stocks and observe their price-action. Here are few steps to follow to track these stocks:

• Go Deep on Parent Company: Assess the core business, their brand value, stock performance, and company structure to clear the foundation.

• Re-Search The Division: Know all about the functioning divisions, including the revenues, growth forecasts, profitability metrics to keep a track on the unit. Compare the data with other functioning competitor’s divisions for a relative examination.

• Do Not Miss-Out The Corporate Affairs: Follow all corporate news, quarterly, annually, or half-yearly reports. Get a good hold on to the corporate news to know your investment inside out. 

• Zoom For Spin-Offs: Pay close attention to any news of separate performance plans of the tracking stocks, if the parent company has any. 

• Bid A Fair Value: Ensure to put out the right investment on the division value. Do not mistake the whole company’s performance as the division performance. 

While considering these points, you can list blue-chip tracking stocks that can gain you good in your portfolio. To add extra, add technical analysis in the list and there you go – a foolproof study of your investment. 

It’s Wrap

In a nutshell, tracking stocks is kind of a special form of a company’s stock that boasts the success of a specific department of a company, despite the entire company itself. Contrary, these stocks perform in the same way as regular stock, paying dividends on the basis of volume of buyers they invest in. But as we know, all the stocks in the market come with risks and rewards so is tracking stocks. Hence it is crucial for traders to do their technical and fundamentals before making a big leap of tracking stocks investment in their trading journey. 

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