Look beyond the “hot” IPOs listed in Canadian stock market news and look for the less noticeable spinoffs to increase the potential for profitable investing

A rising stock market and improving economy can spur investor demand for new stock issues (also known as IPOs, short for initial public offerings). If this tempts you, it pays to keep in mind that new share issues 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.

Underwriters like to set a price on new stock issues that takes advantage of rising public demand—they want to “charge what the traffic will bear,” as the saying goes. It can mean that prices rise from an already inflated level, with no corresponding rise in value.

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If reading Canadian stock market news sparks your interest in a “hot new issue,” exercise caution

When investor interest in new issues is rising, “hot new issues” become more common. That’s what happens when a new issue attracts a lot of interest and it begins trading above the new issue price in the “aftermarket” (that is, the public trading that follows the sale of the shares created by the new issue.)

A price spurt for a hot new issue is a short-term phenomenon. It’s hard to predict, even if you work for the underwriter or underwriting group that brings the issue to market. Even if you could predict which IPOs were going to become “hot,” it wouldn’t necessarily do you any good. That’s because the best judges of a new issue’s potential to go “hot” are the brokers who do public presentations to try to stir up interest in the issue. If they see a lot of interest in a new issue, they reserve the shares for their best clients.

Starting out as a hot new issue doesn’t tell you anything about a company’s long-term future. But if you buy a new issue at a price that is substantially above its new-issue price, you run a greater risk of poor long-term returns, if not a loss.

Search Canadian stock market news for spinoffs instead of IPOs for a better source of profits

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. (For that matter, the parent companies also tend to outperform comparable firms for several years after a spinoff.)

Spinoffs make more sense than IPOs for a few reasons.

First, an IPO is the initial sale of stock by a company as it goes public. Initial public offerings often have a turbulent start on the stock market. Shareholders often sell a portion of their shares to recoup their investment during the first weeks and months the stock begins trading. We generally advise investors to stay out of IPOs.

Second, company managers naturally prefer to acquire or expand their assets, not get rid of them. Getting rid of assets reduces a company’s total potential profit. This cuts into the funds available to pay managers, and reduces their opportunities for career advancement. The management of a parent company will only hand out 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.

Third, spinoffs involve a lot of work and legal fees. The parent will only spin off the unwanted subsidiary if it can’t sell the stock 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 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.

We’ve had great success with a number of spun-off stocks over the years. That’s especially true of the many spinoffs we have recommended that have gone up after they began trading, and have later attracted a takeover bid at a substantial premium to their market price.

Spinoffs and their parents do sometimes run into unforeseeable woes. But on the whole, in investing, spinoffs are the closest thing you can find to a sure thing.

Follow our three-part Successful Investor approach to spot winners among the stocks that you read about in Canadian stock market news

1. Invest mainly in well-established, dividend-paying stocks;
2. Spread your money out across most if not all of the five main economic sectors (Manufacturing & Industry; Resources; Consumer; Finance; and Utilities);
3. Downplay stocks in the broker/media limelight.

How do you look beyond misleading information and get value from Canadian stock market news?