Topic: Spinoffs

Recent Stock Spinoffs Attract Value Investors—For a Reason

Investors looking for undervalued investments will often keep a sharp look out for the most recent stock spinoffs. That’s because these are typically a great way to pick up good stocks at low prices.

Value investors—and investors following our Successful Investor approach—look for recent stock spinoffs because study after study has shown that after an initial adjustment period of a few months, stock spinoffs tend to outperform groups of comparable stocks for several years.

Value investors zero in on financial statistics and ratios as an indicator of what to buy. They like to buy stocks with low ratios of stock price to per-share earnings, cash flow, sales, book value, and so on. They assume that if they get enough value in their stock buys, indicated by low figures for these ratios, their long-term opportunity for growth is greatly enhanced. For example, the problem is that while a, say, 9.0 p/e might look highly attractive, the share price can still move lower and cut the p/e down even further. Then too, a low p/e is no guarantee that the “e,” or earnings, won’t drop. (When the “e” drops, the p/e automatically shoots back up again.)


They outperform comparable stocks for years

“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 companies spin off a subsidiary or division and hand out shares to their shareholders. 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….” Pat McKeough shows how spinoffs and other “special situations” can create windfalls for informed investors.

 

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Value investors and the hunt for the most recent stock spinoffs

If you meet a large number of investors over a large number of years, it may seem they come in two basic categories—one inclined toward value investing, the other more interested in growth. This may be due in part to their early life experiences.

Value investing—trying to buy assets at bargain prices—has natural appeal for those who grew up in strained economic circumstances. Growth investing—trying to identify and buy rising stocks when they have further growth ahead—seems to appeal more to those who grew up in prosperous households. Both can fit into a Successful Investor portfolio.

Academic studies suggest that on average, value investing produces better results than growth investing. But these studies mostly look back on what would have happened in a particular historical period, if you followed a particular set of rules. Most distinguish between growth and income investing by looking at average p/e’s (per-share price-to-per-share earnings ratios). They assume high p/e’s are a marker for growth stocks and low p/e’s for value stocks. As any serious value or growth investor can tell you, it’s more complicated than that.

Recent stock spinoffs are typically undervalued stocks

Companies sell spinoffs when they feel it isn’t a good time to sell, often resulting in undervalued stocks. That probably means it’s a good time to buy.

When a recent stock spinoff begins trading, it stands to reason that investors will put a low price on it. After all, the spinoff hits the market with a large number of neutral, if not reluctant, stockholders who have limited expectations for it, and who are willing to sell when they get around to it.

One group of investors who might be willing to buy a new spinoff are seekers of undervalued stocks. On the whole, it pays to follow the lead of these value seekers. You should also have the patience to hang on through a period of sluggish trading, while reluctant spinoff holders exercise their urge to sell.

Bonus tip: Maximizing long-term profits with value investments

One of the key principles of our Successful Investor philosophy is to buy high-quality “value stocks”: They’re stock picks that are reasonably priced, if not cheap, in relation to their sales, earnings and assets. Typically, value stocks trade at prices lower than their financial fundamentals would suggest.

As more investors come to recognize the value of these stocks, they often begin to rise. Well-informed investors who recognized the value when the stock price was lower then benefit from the rise.

When you start investing, you may see the secret to investment profit as “buy low, sell high.” But that’s hard to do consistently. You’ll often buy just before prices fall, or sell just before they rise. However, if you stick to high-quality value stock picks, like those we recommend with our Successful Investor approach, your short-term gains and losses can average out but you’ll still show above-average profits in the long run. Here are some key factors to look for when judging an undervalued stock’s investment quality:

  • Manageable debt.
  • Freedom to serve (all) shareholders.
  • Freedom from business cycles.
  • Ability to profit from secular trends.
  • Industry prominence if not dominance.
  • Geographical diversification.
  • Ownership of strong brand names and an impeccable reputation.

Stock spinoffs can be volatile depending on the state of the market. What would persuade you invest in a recent stock spinoff when the market is weak and its potential is tougher to achieve?

What are some recent stock spinoffs you regret not buying?

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