Savvy investors who track upcoming spinoffs position themselves to tap some of the market’s best performers

As a general rule, for any upcoming spinoffs we like, it’s better to buy more of any shares you receive, rather than selling them. In fact, a number of studies have 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 that do the spinning-off tend to outperform comparable companies for several years after the split. Needless to say, some spinoffs and their parents sometimes run into unforeseeable woes. However, human nature makes it a good bet that both the parent and spinoff will prosper.

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.

Upcoming spinoffs and the value of patience

When a 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. Most are willing to sell their shares 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, and to hang on through a period of perhaps sluggish trading while other, reluctant spinoff holders sell.

Studies show that there is little reason to doubt that most upcoming spinoffs will have the same results as historical stock spinoffs

The above-average performance of Spinoffs makes sense for a couple of reasons.

First, the management of a parent company will only hand out shares in 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 it.

Second, the parent will often spin off the unwanted subsidiary only if it can’t sell the business 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 for investors 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 is too small to make an impact on the parent’s much larger financial statements and market capitalization.

Another way to profit with spinoff investing

Our TSI Takeover Target Rating considers a range of factors to determine the chances of a spinoff company attracting takeover interest.

Here’s a look at five of those key factors:

• The absence of a major shareholder and little regulatory or anti-trust constraints.
• General profitability, with low debt.
• Hidden assets such as a strong customer base, real estate, or well-known brand names.
• Top-quality, but underperforming, assets. Prospective buyers within an industry look at a spinoff company’s poor management or the lack of financial resources limiting its growth as an opportunity for a big profit boost.
• A total market value that makes the spinoff a manageable purchase for a major competitor.

We’ve had great success with spinoff investing over the years. That’s especially true in the case of spinoffs that have gone up after they began trading and that have later attracted a takeover bid at a substantial premium to the market price.

What are some upcoming spinoffs that you’re excited or wary about?