Tracking Stock Basics

Hi All,

Financial markets can offer a bewildering array of investments to choose from. For those of you who are interested in hardcore investment management you may have heard of something called a tracking stock. For those of you who have not, here are the basics.

What are tracking stocks?

Essentially, a tracking stock is a special equity offering issued by a company that is based on the operations of a subsidiary of that firm. The tracking stock is not traded on the value of companies earnings, rather its price is impacted by the operations of the specific division. Usually these investments are issued by big conglomerates.

There are some serious disadvantages to tracking stocks.

First, tracking stocks typically have limited or no voting rights. So, you don’t get a say in how the division is run. Instead most management decision rights are retained by the parent corporation. While most small investors don’t have much of a say anyways, the principle matters.

Second, tracking stocks are not backed by corporate assets in the same way that common stocks are. With common stocks you are legally entitled to a cut of the companies assets if things go sour. However, with tracking stocks, the company owns the assets, not you.

Third, tracking stocks can impact management decision making. Corporate management and boards must often operate under material and resource constraints, so sometimes they are forced to trade off the interests of common and tracking shareholders. From the standpoint of being a shareholder its better if your interests are fully aligned with those of management. That is, you don’t want these kinds of management tensions.

Why are tracking stocks issued?

Most of the time tracking stocks are issued when the parent company feels they have a super successful division whose value isn’t well reflected in the overall corporations share price. This can be useful if companies want to merge, form strategic alliances or if they want to create incentive structures for their employees.

Notably, some tracking stocks have been substantial failures. For example, at one point the Walt Disney Corporation was going to spin off its internet division go.com. Go.com turned out to be a dismal failure due to web users preference for search engines rather than top down corporate portholes. Similarly, AT&T and Sprint both issued tracking stocks, neither of which are still trading today.

Should You Buy Them?

The bottom line is: relative to common stocks, tracking equities don’t give you the same legal rights, or the same say in corporate management. They are often issued for corporate purposes and tend not have a lot of longevity. All of these suggest they are not good candidates for a buy and hold strategy. Where you have other options, you should probably consider them.

Thanks,

James