Tracking Stock: Overview

A tracking stock is a specific type of stock issued by a parent company to represent the performance of a certain business sector or subsidiary. Unlike ordinary stocks, tracking stocks do not provide ownership of the parent company's assets. Instead, they give exposure to a division's financial success, letting investors to focus on specific areas of growth. 

Tracking stocks is frequently used when a corporation wants to promote a high-performing sector without totally separating it. While these equities can gain depending on the segment's success, they also pose distinct dangers because they are still subject to the parent company's general governance and structure.
 

What Is a Tracking Stock?

A tracking stock is a type of equity issued by a parent company, representing the performance of a particular division or subsidiary. While it trades like regular shares, it is tied specifically to the financial results of the targeted segment rather than the entire company. This allows investors to focus on the growth and profitability of that specific unit. 

However, tracking stocks do not convey ownership in the company’s other assets or provide control over the parent firm. They are often created when a company wants to highlight a successful segment while keeping it within the larger organization. Tracking stocks can be riskier due to their dependence on the performance of a single business segment.
 

Benefits of Tracking Stock

Tracking stocks has various advantages for both companies and investors. Companies can showcase the performance of a certain high-growth segment by issuing tracking stocks rather than spinning it off altogether. This can attract specific investors and increase the value of that section. It also gives the parent company more strategic freedom in controlling and expanding various business divisions. 

Tracking stocks allow investors to invest in a specific division that they feel has high development potential while avoiding exposure to the parent company's less lucrative parts. Furthermore, monitoring stocks gives insight into the financial performance of a certain division, allowing for better educated investing selections.
 

Risks in Tracking Stocks

Tracking stocks involves significant risks that investors must consider. Because they are linked to the success of a certain business unit, they can be extremely volatile if that division experiences difficulties, even if the parent company remains steady. Investors in tracking stocks have less rights than regular shareholders; they often lack voting power and have no claim to the parent company's assets. 

Furthermore, the parent firm retains authority over the monitored division, which may result in conflicts of interest or adverse choices affecting the segment's performance. Finally, because tracking stocks are connected to a single unit, they lack the diversity that is generally used to manage risk across a company's operations.
 

Disadvantages of Tracking Stock

Tracking stocks have notable disadvantages that investors should be aware of. First, they often lack voting rights, meaning shareholders have little influence over company decisions. This can lead to conflicts of interest, as the parent company retains control and might prioritise its overall strategy over the tracked division's interests. 

Additionally, tracking stocks are tied to the performance of a single business unit, making them more volatile and riskier than regular shares, especially if the tracked division underperforms. Another drawback is limited access to dividends, as any profit distribution is usually at the discretion of the parent company. Lastly, because tracking stocks are not independent entities, their value can be impacted by broader company issues, reducing their investment appeal.

Example of Tracking Stocks

In India, Tata Motors' DVR (Differential Voting Rights) shares are a famous example of tracking stock. Tata Motors introduced these shares, which are related to the company's performance and function similarly to tracking stocks. Although not technically tracking stocks, Tata Motors DVR shares are intended to mirror the company's operational performance while providing less voting rights than regular shares. 

In exchange for less voting rights, they pay higher dividends, which appeals to investors who value profits above power. This concept, while not identical to classic tracking stocks, is related in that it allows investors to target certain areas of a company's performance while accepting minimal control over governance.

Conclusion

Tracking stocks offer a unique way for investors to focus on specific high-growth segments of a company while providing businesses with flexibility in managing their operations. However, these stocks come with risks, such as limited voting rights, potential conflicts of interest, and higher volatility due to their dependence on the performance of a single unit. 

Despite these drawbacks, tracking stocks can be beneficial for both investors and companies when used strategically. Understanding both the benefits and risks is crucial for making informed investment decisions in tracking stocks.