One of the ways a company can try to unlock its own hidden value is by creating a separate company out of a subsidiary. The parent company can either sell stock in the new company to the public, or spin it off—hand the stock out to its own investors. In the past few years, it has become common to do both.

Often, the parent company starts by selling a portion of the new company to the public, to establish a market and a following among investors. That way, by the time of the spin-off, stock in the new company may be liquid enough to be sold relatively easily, or retained with some confidence as a worthwhile investment.

In our experience, and in most academic studies of the subject, this helps the parent and the spin-off. Both generally do better than comparable companies for at least several years after the spin-off takes place.

We can say without reservation that, in investing, spinoffs are the closest thing you can find to a sure thing. It all comes down to the incentives.

When a company carries out a spinoff, it sets up one of its subsidiaries or divisions as a separate company, then hands out shares in the new company to its own shareholders. It may hand out the shares as a special dividend, or give its shareholders an opportunity to swap shares of the parent company for the shares of the newly established spinoff.

Study after study has shown that after an initial adjustment period of a few months, spinoffs tend to outperform groups of comparable stocks for several years. (For that matter, the parent companies also tend to outperform comparable firms for several years after a spinoff.) The above-average performance of spinoffs makes sense for a couple of reasons.

First, company managers naturally prefer to acquire or expand their assets, not get rid of them. Getting rid of assets reduces a company’s total potential profit. This cuts into the funds available to pay managers, and reduces their opportunities for career advancement. The management of a parent company will only hand out a subsidiary to its own investors if it’s nearly certain that the subsidiary, and the parent, will be better off after the spinoff than before.

Second, spinoffs involve a lot of work and legal fees. The parent will only spin off the unwanted subsidiary if it can’t sell the stock for what it feels it’s worth. That’s why companies only have an incentive to do spinoffs under two sets of favourable conditions: When they feel it isn’t a good time to sell (which often means it’s a good time to buy); or, when they feel the assets they plan to spin off will be worth substantially more in the future, possibly within a few years.

Quite often, a big company will spin off a small subsidiary because it feels the subsidiary is a tiny gem, but that it’s too small to make an impact on the much larger financial statements and market capitalization of the parent.

In spinoffs, the incentives work in your favour. This is easier to understand if you contrast spinoffs to one of the least desirable investments, new stock issues, where the incentives all work against you.

New issues (also known as Initial Public Offerings or IPOs) come to market when it’s a good time for the company or its insiders to sell. That’s not necessarily—and often isn’t—a good time for you to buy. In addition, the underwriting brokerage firms try to spark investor interest in the new issue. They hire public relations firms to get the media interested. They also pay extra commission (double the regular rates or more) to spur their salespeople to sell the new issue.

This tends to create a high-water mark in the price of the issue. After it hits the market and the hype dies down, its price may languish for months or years.

Some new stock issues—so-called “hot new issues”—begin moving up as soon as they hit the market. Some hot new issues even “gap upward” on their first day of trading; that is, their first public trading takes place well above the new issue price. This possibility attracts buyers who fail to appreciate how rare it is, not to mention how unlikely it is that they will get to buy a hot new issue at the new issue price.

After all, the underwriting brokers can generally tell when a new issue is going to be “hot”, based on the reaction of their biggest clients (who of course get first pick on all new issues), and the media. Brokers reserve most of their allotments of hot new issues to their biggest and best clients. New clients and occasional new issue buyers may get to buy token amounts of a hot new issue, if any.

Your best course as an investor is to stay out of most new issues, even those that seem to have serious appeal. It’s better to hold off on buying until a new issue has been trading for a few months if not years, and has shown some of the potential that the initial hype promised.

We’ve had great success with a number of spun off stocks over the years. That’s especially true of the many spinoffs we have recommended that have gone up after they began trading, and have later attracted a takeover bid at a substantial premium over the market price.

Needless to say, things don’t always work out this well. Spinoffs and their parents do sometimes run into unforeseeable woes. But on the whole, in investing, spinoffs are the closest thing you can find to a sure thing.

We also sift through thousands of stocks, digging deeply to discover which are ripe for spinoffs—and which spun off stocks may be in line for takeovers.

When an acquiring company makes a bid to assume control of a target company, it often pays a high price to buy a majority stake. Takeovers consistently offer a windfall to investors holding the shares of the target stock.

Both spinoffs and parents experience an unusually high incidence of takeovers, according to Journal of Financial Economics study.

We have created an exclusive proprietary rating system—our Takeover Target Rating—that will alert you to these rare but highly profitable opportunities.

To give investors advance notice of the possible takeover of a recent spinoff, or its former parent, we zero in on 13 factors that enhance its appeal to potential buyers. Here are three:

• Operates in a consolidating industry, which enhances its appeal for competitors seeking economies of scale.
• The company has good management/industry experts that the buyer can put to more profitable use.
• Profit margins are lower than industry norms. That leaves room for the buyer to cut costs and improve profits.

Here’s a classic example:

Fording Canadian Coal Trust was one of five spinoffs from the original Canadian Pacific Railway Ltd. When we recommended it in January 2008, it was trading at $47. We liked its prospects as a major metallurgical coal producer for steelmaking, and its steady cash distributions to shareholders. And we liked its appeal as a takeover candidate.

Not long after we recommended it, Teck Cominco (now Teck Resources) launched a takeover bid that pushed Fording’s shares up 162.3% in five months!

We also carefully monitor the market for stocks that have drawn the attention of activist investors.

Typically, activist investment firms buy large numbers of a company’s shares often to obtain seats on the company’s board and effect a major change in the company. When activists take hold, new growth is often in store—and we alert investors to the benefits ahead.

Activist investing has surged in the past decade, led by a relatively small but powerful group of activist hedge funds. They follow different strategies, but all have the same goal of wringing the greatest possible profits from the company’s assets.

For example, Mentor Graphics is a company that makes systems to improve the design and speed the development of electronic products (with many clients in the auto industry). It also fit the criteria of an appealing takeover candidate.

In October 2016, a year after we made it a buy, Mentor jumped 7% after activist investor group Elliott Management Corp. revealed that it had doubled its stake in the company. Elliott had a record of coaxing smaller firms into the arms of bigger ones.

And just a month later, German conglomerate AG Siemens bid for Mentor, and completed the all-cash takeover in April. In the brief period between the bid and the takeover, the stock jumped 50.8%.

Here are some spinoff stocks (and their former parents) that we still think have gains ahead. As well, we look at a spinoff ETF.

(New York symbol CAG; Shares outstanding: 478.1 million; Market cap: $13.9 billion; http://www.conagrabrands.com/) makes packaged foods, including Chef Boyardee canned pasta, Hunt’s tomato sauce, Orville Redenbacher popcorn and Reddi-wip whipped cream.

In November 2016, the company spun off Lamb Weston (see below) as a separate firm. Under the terms of the spinoff, Conagra investors received one Lamb Weston share for every three shares they held.
Conagra’s sales rose 28.7%, from $9.54 billion in 2019 to $12.28 billion in 2023 (fiscal years end May 31). That’s mainly because people ate more meals at home due to COVID-19 lockdowns. The company also raised its selling prices to offset rising costs for ingredients, packaging and shipping.

If you factor out unusual items, earnings jumped 44.2%, from $894.2 million in 2019 to $1.29 billion in 2021. Due to more shares outstanding, per-share earnings rose 31.3%, from $2.10 to $2.64. Earnings then fell 10.6%, to $2.36 a share (or a total of $1.19 billion) in 2022 due to higher costs for food ingredients and other inputs. In 2023, earnings rebounded 17.4%, to $2.77 a share (or $1.33 billion), partly due to better productivity.

In its fiscal 2024 third quarter, ended February 25, 2024, Conagra’s sales fell 1.7%, to $3.03 billion from $3.09 billion from a year earlier. If you exclude businesses it bought and sold, as well as currency rates, sales declined 2.0%. That’s due to lower prices (down 0.2%) and a 1.8% drop in volumes. The lower sales also cut earnings before unusual items by 9.2%, to $0.69 a share (or a total of $328.9 million) from $0.76 a share (or $366.0 million).

Conagra has now launched new, lower-priced value products that should help it compete with generic store brands. Even so, earnings for all of fiscal 2024 will probably drop 5% to $2.63 a share. However, lower raw material costs should lift earnings to $2.70 a share in 2025. The stock trades at just 10.7 times that 2025 forecast.

As well, with the August 2023 payment, Conagra raised your dividend by 6.1%. Investors now receive $0.35 a share, up from $0.33. The new annual rate of $1.40 yields a solid 4.8%.

Conagra Brands is a BUY.

(New York symbol LW; Shares outstanding: 144.4 million; Market cap: $12.4 billion; http://www.lambweston.com/), is a leading producer of frozen french fries, potatoes and other packaged vegetables.
Lamb Weston’s sales jumped 42.4%, from $3.76 billion in 2019 to $5.35 billion in 2023 (fiscal years end May 31). That increase is partly due to its $564.0-million buyout in February 2023 of its partner in a joint venture. Specifically, Lamb Weston paid that partner—Netherlands-based Meijer Frozen Foods B.V.—for its 50% stake in the business, which operates four processing facilities in the Netherlands and one in the U.K.; it also holds 75% of an Austrian plant.

Due to the pandemic’s impact on the company’s potato farmers and processing plants, Lamb Weston’s earnings before unusual items fell 35.4%, from $3.22 a share (or a total of $474.8 million) in 2019 to $2.08 a share (or $304.1 million) in 2022. The Meijer transaction lifted earnings to $4.68 a share (or $679.1 million) in 2023.

Lamb Weston’s sales in its fiscal 2024 third quarter, ended February 25, 2024, rose 16.3%, to $1.46 billion from $1.25 billion a year earlier.

If you exclude the contributions from its acquisition of the Meijer stake and problems related to the implementation of a new computerized inventory system, overall sales in the quarter fell $152.0 million compared to a year ago. Without unusual items, including a writeoff of excess raw potatoes in inventory, earnings fell 18.4%, to $1.20 a share (or a total of $175.0 million) from $1.47 (or $212.4 million).

Lamb Weston has now fixed the problems with its new computer system. Its forecast earnings should improve from $5.52 a share in 2024 to $6.25 in 2025, and the stock trades at a moderate 13.8 times that 2025 estimate.

The company also raised your quarterly dividend with the March 2024 payment by 28.6%, to $0.36 a share from $0.28. The new annual rate of $1.44 yields 1.7%.

Lamb Weston is a BUY.

(New York symbol YUM, Shares outstanding: 281.6 million; Market cap: $38.6 billion; www.yum.com) spun off its Chinese operations—Yum China Holdings (see below)—as a separate company on November 1, 2016.

Investors received one share of Yum China for each Yum Brands share they held. They won’t have to pay capital gains tax on those shares until they sell them.

Yum Brands now operates 55,129 restaurants in over 155 countries—70% of those outlets are outside of the U.S. Its main banners are KFC (fried chicken), Pizza Hut and Taco Bell (Mexican food).
In the past few years, Yum has shifted most of its outlets to franchisees—they now operate 98% of all locations. As a result, the company gets most of its revenue from fees it charges those operators, usually 3% to 6% of their sales.

A key part of Yum’s growth strategy is to expand its chain by 4% to 5% a year. Despite 808 gross new outlets , Yum’s revenue in the first quarter of 2024 fell 2.9%, to $1.60 billion from $1.65 billion a year earlier. The lower sales are largely because bad weather hurt traffic at its U.S. locations. As well, KFC is facing strong competition from other fast-food chicken sellers, while the conflict in the Middle East hurt sales at its international division. However, thanks to lower interest costs and taxes, earnings before unusual items rose 8.5%, to $1.15 a share (or a total of $328 million) from $1.06 a share (or $310 million).

Yum’s earnings will probably rise 10% in 2024 to $5.69 a share, and the stock trades at a reasonable 24.1 times that forecast. The company also raised your quarterly dividend by 10.7% with the March 2024 payment. Investors now receive $0.67 per share instead of $0.605. The new annual rate of $2.68 yields 2.0%.

Yum Brands is a BUY.

(New York symbol YUMC; Shares outstanding: 387.9 million; Market cap: $13.6 billion; www.yumchina.com), is China’s largest fast-food operator with over 14,000 outlets, mainly under the KFC and Pizza Hut banners.

The company now plans to expand by 2026 to 20,000 outlets, mainly in 1,100 cities where it does not yet operate. Those new outlets should lift its systemwide sales by 8% to 12% annually over the next three years.

Yum China also continues to benefit from its new loyalty programs (altogether, they now claim over 100 million members) and its expanded home delivery and mobile payment options.

The stock has jumped 40% since the company’s spinoff from Yum Brands. It now trades at a 16.1 times the $2.18 a share Yum China will likely earn in 2024.

That’s a reasonable p/e as expanding prosperity in China makes the company’s products more affordable. As well, it has built up its own distribution networks and warehouses in the 30 years since Yum Brands first began operating in China. That gives Yum China an advantage over other fast-food chains.

Yum China is a BUY.

(Toronto symbol FSV; Shares outstanding: 45.0 million; Market cap: $9.3 billion; www.firstservice.com), set up its commercial real estate business, Colliers International Group (see below), as a separate company on June 2, 2015.

Investors received one Colliers share for each FirstService share they held.

With the spinoff completed, FirstService has carried on with its residential property management and its commercial and residential property improvement services.
In the first quarter of 2024, FirstService spent $31.6 million on acquisitions (all amounts except share price and market cap in U.S. dollars). Those new businesses helped lift its revenue in the quarter by 13.7%, to $1.16 billion from $1.02 billion a year earlier. However, due to fewer weather-related restoration projects and higher interest costs, earnings fell 21.2%, to $0.67 a share from $0.85.

The stock trades at a high, but still acceptable, 31.6 times the $4.77 a share that the company will probably earn in 2024. The $1.00 dividend yields 0.7%.

FirstService is a BUY.

(Toronto symbol CIGI; Shares outstanding: 50.2 million; Market cap: $7.5 billion; www.colliers.com) offers a range of services, including helping clients buy and sell commercial real estate, arranging financing, and assessing properties for tax purposes.
Colliers uses acquisitions to enhance its market share and spur its long-term growth. Those purchases helped lift Colliers’ revenue in the first quarter of 2024 by 3.7%, to $1.00 billion from $965.9 million a year earlier (all amounts except share price and market cap in U.S. dollars). However, lower income from affiliates and higher taxes cut earnings before one-time items by 10.5%, to $0.77 a share from $0.86.

For the full year, Colliers expects its earnings will rise between 10% and 20%. Based on the midpoint of that range, the company will likely earn $6.15 a share in 2024, and the stock trades at a reasonable 17.9 times that forecast. The $0.30 dividend yields 0.3%.

Colliers International Group is a BUY.

(New York symbol BR; Shares outstanding: 118.2 million; Market cap: $23.2 billion; www.broadridge.com), began trading on April 2, 2007, after former parent Automatic Data Processing handed out Broadridge stock to its own investors as a special dividend.

Broadridge is best known for processing and distributing proxies and regulatory filings for nearly every publicly traded U.S. company and mutual fund, both electronically and by surface mail. That segment comprises about three-quarters of the company’s annual revenue. Fees are tied to the volume of communications that Broadridge delivers—a surge of interest from individual investors in the last few years has led to a wider group of investors holding more stocks and funds. That translates into increased business for Broadridge.

Broadridge also has other businesses providing software to handle back-office functions for money managers, broker-dealers, and other capital markets institutions—including trade processing, record-keeping, accounting, and more.

In its fiscal 2024 third quarter, ended March 31, 2024, Broadridge’s revenue rose 4.9%, to $1.73 billion from $1.65 billion a year earlier. The company continues to sign new clients to long-term contracts, which cuts its risk. Excluding one-time items, Broadridge earned $2.23 in the quarter. That was up 8.8% from $2.05.

Broadridge stands to gain from the growing push by the financial services industry to improve efficiency and lower costs. New regulations in the U.S. (Regulation Best Interest) and Europe (Shareholder Rights Directive) also brighten its outlook.

Longer term, growing consumer demand for passive investment products like ETFs should also benefit Broadridge and its investor communications unit. In the meantime, the integration of recent acquisitions is going well and continues to boost the company’s profitability.

The company will likely earn $7.78 a share in the fiscal year ending June 30, 2024, and the stock trades at 25.2 times that forecast. That’s reasonable given its growth prospects.

Meanwhile, Broadridge last raised its quarterly dividend in October 2023, when it paid investors $0.80 a share, up 10.3% from $0.725. The new annual rate of $3.20 yields 1.6%. That’s a relatively low yield—but the company has raised its dividend each year since Automatic Data Processing spun it off in 2007.

Broadridge is a BUY.

The Invesco S&P Spinoff ETF $70 (New York symbol CSD; Market cap: $60.4 million; www.invesco.com), aims to track the S&P U.S. Spin-off Index. The ETF’s MER is 0.65%.

The S&P U.S. Spin-off Index consists of 30 companies that have been spun off within the past four years. They must also have a market capitalization (or the total value of a company’s outstanding shares) of at least $1 billion U.S.

S&P defines a spinoff as any firm resulting from either of the following events: a parent company’s distribution of shares in a subsidiary to its own shareholders or “partial initial public offerings,” in which a parent company sells a percentage of a subsidiary’s shares to the general public.

The ETF’s top holdings include GE Vernova (spun off from General Electric), Constellation Energy (Exelon), Veralto (Danaher), GE HealthCare Technologies (General Electric) and DT Midstream (DTE Energy).

The Guggenheim S&P Spinoff ETF is a HOLD, but only for aggressive investors.