Some investment observations are so basic and indisputable that in my opinion they deserve to be referred to as “laws”. One good example is what I call “McKeough’s Law on New Issue Timing,” which is this: New issues come to market when it’s a good time for the company and/or its insiders to sell, but that’s not necessarily a good time for you to buy.

Underperforming stocks, not undervalued stocks

We hardly ever recommend buying new issues when they are first sold to the public. For that matter, we generally stay away from new issues for months, if not years, after they first come to market. As a group, new issues underperform the market over long periods. In addition, their results are far more variable than those of well-established stocks, and they expose you to greater risk of major loss.

Of course, many new issues do look like undervalued stocks and go up when they first hit the market. These are the “hot new issues” that everybody wants to buy. Unfortunately, hot new issues are always in short supply. Individual brokers get only a limited allotment, so they usually reserve them for their biggest and most profitable clients.

Long-term risk – not as undervalued as you might think

This long-term risk is much higher in new issues that come on the market in response to strong investor demand. This was true of the new-issues boom in Internet stocks in the late 1990s. It was also true of the new issues boom in income trusts in the earlier part of this decade.

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When brokers see that investors are eager to buy a particular type of investment, they make greater efforts to cash in on that demand by bringing more of the investment to market. That means the average quality of new issues in popular market areas tends to go down while prices get bid up, sometimes to ridiculous heights. There are exceptions, of course. But this combination of rising prices and falling investment quality leads to bad deals for investors.

Spinoffs – true undervalued stocks

In one sense, a spinoff is the antithesis of a new issue. Companies sell new issues to the public when they feel it’s a good time to sell. They do 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 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 is little, if any, brokerage research available on the company.

The only investors who might be willing to buy a new spinoff are seekers of undervalued stocks who have taken the trouble to read the voluminous material that companies hand out as part of the spinoff process. But on the whole, it pays to follow the lead of these value seekers. You should have the patience to hang on through months of sluggish trading, while reluctant spinoff holders exercise their urge to sell.