Investing in current spinoffs provides you with a great investment opportunity as studies show that spinoffs typically outperform comparable firms for years

When current spinoffs first begin trading, it stands to reason that investors will put a low price on them. After all, the spinoffs hit the market with a large number of neutral, if not reluctant stockholders who have limited expectations for them.

However, all in all, we think that stock spinoffs provide you with great investment opportunities.

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.

Firms use current spinoffs as a way to 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.

Current spinoffs let you profit more than you would with new stock issues

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

In fact, upcoming stock spinoffs provide opportunities that are as close as you can come to a sure thing in investing. Numerous academic studies show that spun-off stocks, and the companies that spin them off, tend to do better on average than comparable companies not involved in spinoffs. Our past record bears out this pattern. Our spinoff buys and their parent companies tend to be among our best recommendations. The academic research and our own experience led us to launch our Spinoffs & Takeovers newsletter.

New issues generally only come to market when it’s a good time for insiders or the company to sell. That isn’t necessarily a good time for you to buy. Often, it’s a good time to stay out.

On those out-of-the ordinary occasions that a new issue does come to market when it’s a good time for you to buy, then you probably won’t be able to buy much if any, at least at the new-issue price. That’s because the underwriters know when they have a “hot new issue” in the pipeline—that is, one whose share price is likely to shoot up as soon as public trading begins. In that case, they reserve most of the shares available at the initial new-issue price for their biggest and best clients.

If you’re not in that favoured group, you’ll have to buy in the after-market, after prices have moved up and the favoured buyers are taking profits.

With new issues, the best rule for conservative, risk-averse investors is to wait till they’ve gone through an industry setback, if not a full-blown recession. By then you’ll know if they’ve matured into high-quality stocks—or instead have joined the ranks of played-out speculative stocks.

Here are five factors to watch for that could lead to the takeover of a current spinoff

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.

Use our three-part Successful Investor approach to build a top portfolio—including current spinoffs

1. Hold mostly high-quality, dividend-paying stocks.
2. Spread your money out across most if not all of the five main economic sectors: Manufacturing & Industry, Resources & Commodities, Consumer, Finance and Utilities.
3. Downplay or stay out of stocks in the broker/media limelight.

Would you still feel compelled to target spinoffs if they underperformed in the market currently?

What is your opinion of investing in spinoff stocks?