Tracking Stock: Definition, Benefits, Risks, and Example

Tracking Stock: Definition, Benefits, Risks, and Example

Tracking stock is a type of equity security that is issued by a parent company to track the performance of a specific business unit or division. It is designed to give investors the opportunity to invest in a specific segment of a company’s operations, rather than the company as a whole.

The main benefit of tracking stock is that it allows investors to have exposure to a specific business unit or division without having to invest in the entire company. This can be particularly attractive for investors who have a strong belief in the potential of a specific segment of a company’s operations, but may not be as confident in the overall performance of the company.

However, there are also risks associated with tracking stock. One of the main risks is that the value of the tracking stock may not accurately reflect the value of the underlying business unit or division. This can be due to a variety of factors, such as market conditions, investor sentiment, or changes in the overall performance of the company.

An example of tracking stock is the tracking stock issued by Alphabet Inc., the parent company of Google. Alphabet Inc. issued tracking stock for its “Other Bets” segment, which includes various business units such as Waymo, Verily, and Nest. By issuing tracking stock for this segment, Alphabet Inc. allows investors to specifically invest in the potential of these business units, separate from the performance of Google’s core search and advertising business.

What is Tracking Stock?

Tracking stock is a type of stock that is issued by a company to track the performance of a specific division or business unit within the company. It is designed to give investors the opportunity to invest in a specific part of the company’s operations, rather than the company as a whole.

Unlike regular common stock, tracking stock does not represent ownership in the company as a whole. Instead, it represents ownership in a specific segment or division of the company. This allows investors to have a more targeted investment strategy and potentially benefit from the growth and success of a specific business unit.

Tracking stock is typically created when a company wants to separate a high-growth division from the rest of the company. By issuing tracking stock, the company can raise capital for the division and provide investors with a way to directly invest in its success.

Tracking stock is often used in industries where companies have multiple business units or divisions that have different growth rates or financial profiles. It allows investors to choose which part of the company they want to invest in based on their own investment objectives and risk tolerance.

In summary, tracking stock is a type of stock that allows investors to invest in a specific division or business unit of a company. It provides a targeted investment strategy and the potential for growth and success in a specific segment of the company’s operations.

Benefits of Tracking Stock

Tracking stock offers several benefits to both companies and investors:

1. Flexibility:	Tracking stock allows companies to create separate classes of stock that track the performance of specific business units or divisions. This provides flexibility in capital allocation and allows investors to choose which part of the business they want to invest in.
2. Value Unlocking:	By issuing tracking stock, companies can unlock the value of specific business units or divisions that may not be fully reflected in the overall stock price. This allows investors to potentially benefit from the growth and success of a particular segment of the company.
3. Risk Mitigation:	Investors can use tracking stock to diversify their portfolio and mitigate risk. By investing in different classes of stock that represent different business units, investors can spread their risk and potentially reduce the impact of any negative events that may affect a specific segment of the company.
4. Transparency:	Tracking stock can provide greater transparency and visibility into the performance of specific business units or divisions. This allows investors to make more informed investment decisions based on the individual performance of different parts of the company.
5. Strategic Focus:	By creating tracking stock, companies can focus on specific business units or divisions and allocate resources accordingly. This can help streamline operations, improve efficiency, and enhance overall performance.

Overall, tracking stock offers companies and investors the opportunity to customize their investments, unlock value, mitigate risk, gain transparency, and focus on specific business units or divisions. However, it is important for investors to carefully evaluate the risks associated with tracking stock before making any investment decisions.

Risks of Tracking Stock

1. Limited Voting Rights

One of the main risks of tracking stock is that it often comes with limited voting rights. This means that shareholders who hold tracking stock may not have the same voting power as those who hold regular common stock. This can limit the ability of tracking stock shareholders to influence corporate decisions and have a say in the company’s direction.

2. Lack of Dividend Payments

In some cases, tracking stock may not be entitled to receive dividend payments. Dividends are a portion of a company’s profits that are distributed to shareholders. If a company decides not to pay dividends on its tracking stock, investors may miss out on potential income.

3. Dependency on Parent Company

Tracking stock is typically issued by a parent company to track the performance of a specific division or business unit. This means that the value of the tracking stock is closely tied to the success or failure of that particular division. If the division underperforms or faces financial difficulties, the value of the tracking stock may decline.

4. Lack of Transparency

Another risk of tracking stock is the potential lack of transparency. Since tracking stock represents a specific division or business unit, the parent company may not provide as much information or financial disclosures about that division compared to its overall operations. This lack of transparency can make it difficult for investors to fully assess the risks and potential returns associated with the tracking stock.

5. Market Volatility

Like any other stock, tracking stock is subject to market volatility. The price of tracking stock can fluctuate based on various factors such as market conditions, investor sentiment, and company performance. Investors should be prepared for potential price swings and the possibility of losing money if the value of the tracking stock declines.

Example of Tracking Stock

Let’s take a look at an example to better understand how tracking stock works. Company XYZ is a conglomerate that operates in various industries, including technology, healthcare, and consumer goods. To provide more transparency and unlock the value of its different business segments, Company XYZ decides to issue tracking stock for each segment.

The first tracking stock, XYZ-Tech, represents the performance of the technology division of Company XYZ. The second tracking stock, XYZ-Health, represents the performance of the healthcare division, and the third tracking stock, XYZ-Consumer, represents the performance of the consumer goods division.

Investors interested in investing specifically in the technology sector can now purchase shares of XYZ-Tech, which will track the financial performance of the technology division. Similarly, investors interested in the healthcare or consumer goods sectors can invest in XYZ-Health or XYZ-Consumer, respectively.

Each tracking stock has its own financials, including revenue, expenses, and profit margins. The performance of each division is evaluated separately, allowing investors to assess the individual performance of each segment.

For example, if the technology division of Company XYZ experiences significant growth, the value of XYZ-Tech tracking stock may increase. On the other hand, if the healthcare division faces challenges, the value of XYZ-Health tracking stock may decrease.

Tracking stock provides investors with the opportunity to invest in specific business segments of a company without having to invest in the company as a whole. It allows investors to align their investments with their specific interests and investment strategies.