Stock spinoff investing is about as close as you can get to a sure thing when looking for stocks to add to your portfolio

Over the years, we’ve found that spinoffs are about as close as you can get to a sure thing in investing. Statistics show that after a company sets up one (or more) of its businesses or divisions as a separate entity and “spins it off,” or hands it out to its shareholders as a special dividend, the shares of both the parent and the spinoff generally do better than comparable companies for a number of years, if not decades.

All in all, we think that stock spinoffs provide great investment opportunities. Our past record bears out this pattern. Our spinoff buys and their parent companies tend to be among our best recommendations. The academic research, combined with our own experience, led us to launch our Spinoffs & Takeovers newsletter.

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Look to stock spinoff investing to find top additions to your portfolio.

It pays to follow most spinoff opportunities wherever they lead.

Spinoffs generally work out well over a period of several years for both the spun-off company, and its stock, as well as the parent. The management of a parent company will only hand out shares in a subsidiary to its own investors if it’s fairly confident that the subsidiary, and the parent, will be better off after the spinoff than before.

Parent companies may devote great effort to ensuring that the spinoff has adequate finances and strong management. They want the spinoff to succeed, for their own prestige, and because they want the spun-off stock to benefit its shareholders.

Furthermore, spinoffs involve a lot of work and legal fees. That’s why companies only have an incentive to implement spinoffs under favourable conditions. For instance, when they feel the assets they plan to spin off will be worth substantially more in the future, possibly within a few years.

Stock spinoff investing strategies let firms unlock hidden value

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 the public stock in the new company (most often through an initial public offering) or spin it off; i.e., hand the stock out to its own investors. In the past few years, it has become common to do both.

Sometimes, the parent company first 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 spinoff, stock in the new company may be liquid enough to be sold relatively easily, or retained with some confidence as a worthwhile investment.

Stick to stock spinoff investing rather than buying new issues

As mentioned, from time to time, companies set up one or more of their divisions or subsidiaries as an independent company, then hand out shares in that company to their own shareholders as a special dividend, or “spinoff.” This mainly happens when the company wants to get rid of the division for operational reasons, but recognizes that the shares offer good value. So, rather than sell that business, the company hands out shares in the new firm to its owners—shareholders in the company.

Initial Public Offerings—also known as IPOs or new issues—are inherently riskier than existing stocks. That’s because most new issues come to market when it’s a good time for a company or its insiders to sell. This may not be, and often isn’t, a good time for you to buy.

In addition to the adverse timing, a new issue involves substantial costs that come out of the proceeds of the new-issue sale. New-issue buyers pay these costs, which are well above the brokerage cost of buying existing issues.

You might say a spinoff is the antithesis of a new issue. Companies do spinoffs when they feel it isn’t a good time to sell. This is often a good time for patient investors to buy.

Use our three-part Successful Investor approach to pick stocks, including stock spinoff investing

1. Invest mainly in well-established, dividend-paying companies, with a history of rising sales if not earnings and dividends.
2. Spread your money out across most if not all of the five main economic sectors: Manufacturing & Industry; Resources & Commodities; Consumer; Finance; Utilities.
3. Downplay or avoid stocks in the broker/media limelight. When stocks spend time in the limelight, they tend to become overpriced, and this leaves them vulnerable to a sharp downturn on any hint of bad news. Instead, look for stocks with hidden value that are less widely recognized—at least so far—as attractive investments.

What has your experience been with investing in spinoff stocks?

Do you actively look for spinoffs in your investing strategy or do you find other investments are more worth your time?