New corporate spinoffs are often the target for value seekers, while new stock issues often pose problems

You can contrast corporate spinoffs with new stock issues, which is when a company first sells shares to the public.

The two situations are like two sides of a coin—one generally favourable to investors, the other, generally unfavourable. The motivations of the companies are nearly opposite.

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.

Corporate spinoffs are more favourable than IPOs, new stock issues

From time to time, companies set up one or more of their divisions or subsidiaries as an independent firm, then hand out shares in that company to their own investors as a special dividend, or as “corporate spinoffs.” Baxter International (spinoff: Baxalta) and eBay (spinoff: PayPal) are two major companies that have done it with great success.

On the other hand, companies sell new issues to the public when they feel it’s a good time to sell. That may not be, and often isn’t, a good time for you to buy.

Patterns associated with new issues

Underwriting brokerage firms try to spark publicity about new issues, and they pay extra commission (as much as double the regular rates) to spur their salespeople to sell the new issues to their clients. This tends to inflate the price of new issues.

But unless the new company can follow up with business success, the price of the new issue may languish for months or years.

Some new stock issues—so-called “hot new issues”—depart from this pattern. They begin moving up as soon as they hit the market. Some 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. In addition, the underwriting brokers can generally tell when this is going to happen, by judging the reaction of their biggest clients (who, of course, get first pick on their new issues), and the media. They reserve most of their allotments of hot new issues to their biggest and best clients.

New clients and occasional new issue clients may get to buy only token amounts of a hot new issue, if any.

Speaking very generally, your best course of action as an investor is to stay out of most new issues. You’re better off to wait until they have been trading for a few years and have shown some of the potential that the initial hype promised.

Even with attractive new issues, it’s generally best to stay out. If a new issue has genuine long-term investment appeal, it will be an attractive buy for months or years after it reaches the market.

In the past, however, we have made money by making an exception to the new issue rule. New issues are more attractive and often easier to obtain when they are part of a privatization effort—when a government sells a government-owned enterprise to investors.

With privatizations, governments often price the new issue at an attractive level that almost ensures that buyers will make money. That’s because governments are less concerned than a private seller would be about getting a good price in a privatization. Instead, they are more concerned about maintaining the goodwill of buyers, for political reasons. Rather than try to get the best price, they may sell a privatization at a good price to a wide range of individual buyers, to win goodwill and votes in the next election.

We generally avoid new issues, but new issues of companies being privatized can be a good deal.

The investors who look for corporate spinoffs

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, and who are willing to sell when they get around to it. Initially there may be little, if any, brokerage research available on the company.

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

Bonus Tip: Losing patience can cause you to sell your best choices right before a big rise

All too often, investors buy a promising stock just as it enters a period of price stagnation. Even the best-performing stocks run into these unpredictable phases from time to time. They move mainly sideways in a wide range for months or years before their next big rise begins. (Stock brokers often refer to these stocks as “dead money.”)

If you lack patience, you run a big risk of selling your best choices in the midst of one of these phases, prior to the next big move upward. If you lose patience and sell, you are particularly likely to do so in the low end of the trading range, when stock prices have weakened and confidence in the stock has waned.

Do you have a different experience to share involving ways you’ve profited from new issues or IPOs?

Some rare new issues can produce big profits. What is your experience with stocks like this?