Have you observed companies issuing certain stocks that seem to belong to their corporation and yet are tracked and priced differently and focus only on its subsidiary? These are known as tracking stocks and while they have largely fallen out of prominence in recent years, they are still an essential concept that new investors in the stock market should know about. So, to help you know more about this concept, here is a closer look at what is tracking stock, why companies issue them and what you should keep in mind before investing in them.
What is a Stock?
Before delving into the tracking stock definition outlined below, let us first review what a stock is and how it serves the needs of a company.
A stock of a company is essentially a type of financial instrument that offers a degree of ownership in the company, as well as a claim on its assets and profits. Stocks are given out by companies at a specific rate per share to interested investors for a variety of purposes such as raising capital, funding expansion or paying off the company’s debts.
What is Tracking Stock?
Now that we have reviewed the concept of stock as understood from a company’s perspective, let us know more about tracking stock meaning.
The first point of note is that tracking stocks are essentially similar to regular stocks in that they are issued by a company, and are bought and sold at the relevant stock exchanges. However, tracking stocks are generally issued by a parent company not to represent the financial performance of the entire company, but rather one of its specific divisions.
This is typically done by large and diversified companies when they believe that one of their divisions has the possibility of attaining a financial performance much different than that of the parent company. In most cases, this means that the division or subsidiary is likely to perform even better than its parent company.
A simple tracking stock example can be understood in terms of a hypothetical, large technology company that has an emerging cutting-edge software division that could prove profitable in the coming years. The tech company might choose to issue separate tracking stocks for this promising division so as not to blend its performance with the rest of the company’s financial performance and prove its own potential.
As is the case with regular shares, tracking stocks offer their holders certain benefits. These include the right to vote on specific policies, dividend payments as well as the right to convert the tracking stock into another class of stock.
Important Points to Note About Tracking Stocks
Now that you have a better understanding of the tracking stock definition as well as a potential example, it might be worth going over a few points about tracking stocks that an investor should keep in mind. Here a few essential things to note about tracking stocks:
– The dividends an investor receives from atracking stock are dependent solely on the financial performance of the division for which the tracking stocks are issued. They do not reflect the performance of the overall parent company. So, if the tracking stock division is doing well while the parent company is not, your stock price will still rise. Meanwhile, if the tracking stock division does poorly, it means that your stock price will still fall despite a good financial performance by the parent company.
– On the other hand, any holders oftracking stocks still have equity in the shares of the parent company.
– While the financial performance of thetracking stock division is separately reported, it still remains bound to the parent company from both a legal and financial perspective. Its financial performance is also ultimately consolidated with the financial report of the parent company.
Hence, tracking stocks are a special form of stock in that they represent a division of a company and not the entire company itself. On the other hand, they are also not much different from a regular stock in that their dividends are based on the performance of the entity you invest in. As is the case with all forms of investments in the stock market, the risks and benefits of tracking stocks must be weighed out for each investor before making the big leap.