What is Muhurat Trading and Why it's...
The muhurat trading is a special one-hour trading session allowed by the stock exchanges on the day of Diwali. Buying and selling shares during the m…
01 Aug, 2022
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Understand what tracking stocks are, who they are used by and the value that they provide.
Defining Tracking Stock
A tracking stock refers to a special equity offering that a parent company issues. It is used to track a certain division or segment’s financial performance. Stocks of this kind are traded in the open market and differ from the parent company’s stocks.
By making use of tracking stocks, it is possible for companies operating on a larger scale to separate the financial performance of a segment of theirs that generates higher growth. With these stocks, investors are provided with the opportunity to gain exposure to a certain aspect of a large company’s business.
Exploring the Mechanisms of Tracking Stocks
Companies that issue tracking stocks separate the revenues and expenses relating to said stock’s division from the parent company’s financial statements. Further, the long-term performance of tracking stock is linked to the financials of the segment it aligns itself with and not the parent company.
Performance
In case the division in question performs well financially, the tracking stock is likely to appreciate even if the parent company’s performance is lacking. That said, in case the division experiences a financial slump, the tracking stock is likely to dip even if the parent company performs well.
Instances of Tracking Stock Issuance
- Large companies may choose to issue tracking stocks in a bid to separate a division that doesn’t quite align with its primary business. For instance, a large retail manufacturing company separates its small electrical division.
- Another instance wherein tracking stocks might be issued relates to the isolation of a high-growth segment from a larger but slower-growth parent company. That said the parent company along with its shareholders remain in control of the segment’s operations.
Rules and Regulations in Place
The registration of tracking stocks is similar to that of common stocks as per the regulations enforced by the Securities and Exchange Board of India (or SEBI). Further, their issuance and reporting are essentially the same as that for new common shares. Companies are expected to create a separate section for their tracking stock and its division’s financials within their financial reports.
Benefits and Risks Involved
Investor Benefits
As far as investors are concerned, these stocks provide investors with the opportunity to invest in a certain area of a much larger business. Well-established conglomerates often have a hard time appreciating in value as they rarely have several divisions across varied business lines. With tracking stock, however, investors get to invest solely in the most promising aspect of a company.
Another advantage for investors relates to them being able to participate in business segments best suited to their respective risk tolerances.
Investor Risks
Investors must be aware of the risks involved when purchasing tracking stock in instances of a parent company struggling. A parent company and its shareholders don’t lose control of the tracking segments’ operations and investors of tracking shares don’t have any voting rights. In case the parent company files for bankruptcy, the creditors would be entitled to claim the tracking segment’s assets.
Company Benefits
It is possible for companies to raise money by issuing tracking stocks. With their proceeds, they can offset any debts they have and/ or fund alternative growth projects. They also have the option to invest in their own division.
An additional benefit relates to assessing investor interest within specific segments of the business model via the activity of every tracking stock. Further, management isn’t burdened with having to create a separate legal or business entity for the tracked division.
Company Risks
Parent companies that issue tracking stocks may be parsing out the most lucrative aspects of their entity. In case this parent company underperforms from a financial point of view, the high-growth division associated with it won’t be able to offset this lacklustre performance.
Additional shortfalls relate to investors losing money on these stocks if the division underperforms despite the parent company performing well. Further, if the parent company files for bankruptcy, creditors may be entitled to the tracking division’s assets. Finally, tracking stockholders ordinarily have limited or no voting rights.
Final Thoughts
Investing in tracking stocks can be a lucrative opportunity provided you proceed with caution and are aware of the shortfalls associated with these stocks. Always assess your own portfolio tracker and take into account the level of risk you are willing to expose yourself to prior to investing in these stocks. Learn more about the same on the Angel One website.
Disclaimer: This blog is exclusively for educational purposes and does not provide any advice/tips on investment or recommend buying and selling any stock.
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