Today, we look at a tech stock that rewarded its shareholders by creating two companies out of one. Late in 2014, Agilent Technologies spun off its electronics testing division, which became Keysight Technologies. Spinoffs are a great way for companies to unlock hidden value, as the former parent and newly independent firm tend to outperform groups of comparable stocks for several years. (for more on what to look for in spinoffs, see below).

In this case, we believe Agilent is the stronger of the two stocks now. This growth stock has a strong niche in testing equipment for medical research labs and continues to expand its product line through acquisition and a firm commitment to research spending. Agilent’s dividend also appears to be secure.

Recently we posted reports on two Canadian stocks that emerged from a spinoff four years ago. We continue to rate both as buys. Toromont Industries aims to gain even more momentum with a mining recovery describes the progress of parent company Toromont. Enerflex equipped for a rebound when oil and gas recover explains why the spinoff is a buy for a rebound.

AGILENT TECHNOLOGIES INC. (New York symbol A; www.agilent.com) split into two publicly traded firms on November 1, 2014.

One company kept the Agilent name and stock symbol and focuses on testing equipment for medical research labs. The other firm, called Keysight Technologies, makes testing systems for electronics.

Under the spinoff, Agilent shareholders received one Keysight share for every two shares they held.

Excluding spinoff-related costs and other unusual items, Agilent earned $147 million, or $0.44 a share, in its fiscal 2015 third quarter, which ended July 31, 2015. That’s up 7.3% from $137 million, or $0.41 a share, a year earlier. Revenue was unchanged at $1.01 billion. Equipment orders fell 6.3%, to $953 million from $1.02 billion.

Growth stocks: Belgian acquisition makes software for Agilent’s medical-testing equipment

Agilent spends around 8% of its revenue on research, and the resulting new products will spur its growth. What’s more, the company recently enhanced its product line by purchasing Cartagenia, a Belgian firm that makes software for Agilent’s medical-testing equipment.

Agilent’s strong balance sheet will support its growth plans: its long-term debt of $1.7 billion is a moderate 14% of its market cap. It also holds cash of $2.1 billion, or $6.25 a share.

The company expects to earn $1.68 to $1.72 a share for all of fiscal 2015, and the stock trades at a reasonable 21.2 times the midpoint of that range. The $0.40 dividend yields 1.1%.

Recommendation in Wall Street Stock Forecaster: BUY

Two favourable conditions for spinoffs

When a company carries out a spinoff, it sets up one of its subsidiaries or divisions as a separate company, then hands out shares in the new company to its own shareholders. It may hand out the shares as a special dividend, or give its shareholders an opportunity to swap shares of the parent company for the shares of the newly established spinoff.

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

First, 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.

Second, 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.

Quite often, a big company will spin off a small subsidiary because it feels the subsidiary is a tiny gem, but that it’s too small to make an impact on the much larger financial statements and market capitalization of the parent.

Needless to say, things don’t always work out this well. 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.