Tracking Stock: Definition, Benefits, Risks, and Example

What Is a Tracking Stock?

A tracking stock is a special equity offering issued by a parent company that tracks the financial performance of a particular segment or division. Tracking stocks will trade in the open market separately from the parent company's stock.

Tracking stocks allow larger companies to isolate the financial performance of a higher growth segment. In turn, tracking stocks give investors the ability to gain exposure to a specific aspect of a larger company's business (e.g., the mobile division within a large telecom provider).

Understanding Tracking Stocks

When a parent company issues a tracking stock, all revenue and expenses of the applicable division are separated from the parent company's financial statements. The long-term performance of the tracking stock is tied to the financials of the division or segment it follows, not the parent company.

If the division does well financially, the tracking stock will likely appreciate even if the parent company is performing poorly. Conversely, if the division slumps financially, the tracking stock will likely fall even if the parent company is doing well.

Large companies might issue tracking stocks in order to separate a segment that doesn't quite fit with the core business. An example would be a large manufacturing company with a small software development division.

Companies also issue tracking stocks to isolate a high-growth division from the larger slower-growth parent. However, the parent company and its shareholders retain control of the division's operations.

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 Benefits and Risks for Investors

Tracking stocks allow investors the opportunity to invest in a particular portion of a much larger business. The appreciation potential of well-established conglomerates is often limited due to them having multiple divisions across various business lines. Tracking stocks can give investors access to only the most promising parts of a company.

Tracking stocks also allow investors to participate in the business segments that best fit their own risk tolerance. That said, investors need to be mindful of the risks involved in buying a tracking stock when the parent company is struggling or not well established.

The parent company and its shareholders do not give up control of the tracking segment's operations. Investors of tracking shares typically have limited or no voting rights and in the event of corporate bankruptcy at the parent company, creditors would have a claim on the tracking segment's assets (even if the segment was doing well).

Tracking Stocks Benefits and Risks for Companies

Companies raise money through the issuance of tracking stocks. The proceeds can then be used to pay down debt, fund other growth projects, or invest further in the tracking division.

Companies can gauge investor interest in specific segments of the business through the associated activity of each tracking stock. For example, a large-scale telecom giant may choose to use tracking stocks to separate its wireless segment and its landline services. Investor interest in each division can be measured based on the performance of each of the tracking stocks.

Tracking stocks also eliminate the need for management to create a separate business or legal entity for the tracked segment. In a spinoff situation, for example, the separated segment would require its own board of directors and management team.

On the flip side, companies that issue tracking stocks might be parsing out the best parts of their company. If the parent company underperforms financially, the high-growth segment associated with the tracking stock won't be able to help offset that poor performance.

Example of a Tracking Stock

In 1999, the Walt Disney Company issued a tracking stock for its internet holdings division, Go.com. Go.com's websites included ESPN.com, ABCNews.com, Disney Online, and Disney's Daily Blast. The tracking stock traded under the ticker symbol "GO."

In January 2001, just as the tech bubble was popping, Disney was forced to close Go.com, lay off hundreds of employees, and retire the tracking stock permanently.