Value seekers target stock spinoff investments because they recognize the potential long-term gain

Seekers of undervalued stocks are most likely to read the voluminous material that companies hand out as part of the stock spinoff process. They’re also most likely to buy a stock spinoff. On the whole, it pays to follow their lead, although that’s not always easy.

When a spinoff begins trading, investors will usually 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. Initially there is little, if any, brokerage research available on the company.

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.  I consent to receiving information from The Successful Investor via email. I understand I can unsubscribe from these updates at any time.

A stock spinoff is often an undervalued stock in disguise

One of the key principles of successful investing 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 begin to rise. Well-informed investors who recognized the value of the stock when its share price was lower will then benefit from its 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. If you stick to high-quality value stock picks, however, your short-term gains and losses can average out but you’ll still profit greatly in the long run.

Stock spinoffs can become some of the biggest undervalued stocks in the market

We can still say without reservation that, in investing, stock spinoffs are the closest thing you can find to a sure thing.

When a company carries out a spinoff, it sets up one of its subsidiaries or divisions as a separate firm, 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 investors an opportunity to swap shares of the parent company for the shares of the newly established spinoff.

4 benefits of stock spinoff investments

1. Spinoffs are born with the proverbial “silver spoon.” Parent companies may devote great effort to ensuring they have adequate finances and strong management. They want the spinoff to succeed, for their own prestige, and because they want spun-off bargain stocks to benefit their shareholders.
2. Share in spinoff stocks may slump when they begin trading. Many investors routinely dump stock they receive in a spinoff. They may only get a handful of shares — perhaps one for each 10 shares they own in the parent company. They may have little familiarity with the new company, and coverage by brokerage analysts and the press is often minimal at first. But after this initial slump, these spinoff stocks generally go on to outperform the market as a whole.
3. Spinoffs have more flexibility. Spinning off unwanted assets lets parent-company managers focus on the part of their business they want to retain. Usually they hold on to the part best suited to their talents.
4. Spinoffs often attract takeover bids from major competition.

Bonus value-stock tips:

Financial and growth characteristics of the best value stocks to invest in

• 5 to 10 year history of profits. Companies that make money regularly are safer than chronic or even occasional money losers.
• 5 to 10 years of dividends. Companies can fake earnings, but dividends are cash outlays. If you only buy dividend-paying value stock picks, you’ll avoid most frauds.
• Manageable debt. When bad times hit, debt-heavy companies go broke first.
• Ownership of strong brand names and an impeccable reputation. Customers keep coming back to these businesses, and will try their new products.
• Freedom from business cycles. Demand periodically dries up in “cyclical” businesses, such as resources and manufacturing. That’s why you need to diversify. Invest in utility, finance and consumer stocks, along with resources and manufacturers.
• Ability to profit from secular trends. These trends outlast ordinary business booms and busts, because they reflect ongoing social change. Free trade and rising environmentalism are just two examples of secular trends.

Stock spinoffs do outperform the market, so why haven’t you invested in them?

Stock spinoffs aren’t usually media favourites, but they almost always have potential to be strong performers. What has been your experience with finding a spinoff outside of the media spotlight?

This post was originally published in January 2018 and is regularly updated.