Investing Tips: Capitalize on Profitable Spinoff Stocks

One of the most underrated and profitable segment of the stock market is a spinoff. A spinoff transaction occurs when a publicly-traded company turns one of its subsidiary businesses into a new, completely separate corporation that becomes publically traded with its own distinct shares. Shares in that new outfit are distributed to the shareholders of the parent company and are also sold like any other stock, to the general public. Buy those and you may reap some phenomenal profits.

spinoff stocks tips

Leveling the Playing Field

Many individual investors are tired of trying to compete with the big Wall Street hedge funds, whose buy and sell orders are so gigantic that they add unwanted, unexpected volatility to the markets. Oftentimes those market-moving professional investors also trade on information not available to the average person. That advantage has been confirmed by high-profile arrests and convictions for illegal insider trading. In September of 2013, for example, a trader pled guilty to tipping off his friends about lucrative deals while he was an investor at Wells Fargo. During the past three years the Securities and Exchange Commission (SEC) filed approximately 400 insider trading cases – the most in any 3-year period in SEC history. The market for initial public offerings, or IPOs, is also dominated by major Wall Street firms, making it very difficult for the ordinary investor to successfully participate in those deals. Their prices are usually inflated by traders who are able to buy large chunks before they distribute shares to the general public.

A Golden Opportunity

The spinoff arena is now one of the only level playing fields left in the stock market game – and it has historically been a goldmine for those who participate. Companies in the USA have completed about 100 spinoffs within the past decade, and shareholders who bought the new entities created by those events have banked returns of about 70%. The parent companies are also a good deal for those who are interested in high-capitalization stocks because they generated returns of about 35% during that same time frame.  If you do the math in your head, it’s easy to figure out that investors who bought both parent company shares and spinoff stocks during the past 10 years have banked total gains of over 100%. That’s not too shabby, even if you’re Warren Buffett.  The number of spinoffs has also accelerated recently, perhaps as a reaction to a recovering economy coupled with a desire by companies to streamline themselves to be leaner and meaner competitors. While 2009 saw only four or five major spinoffs, 2010 saw three times that many and there were about 20 mega deals that resulted in attractive companies getting spun into existence last year.

Discount Prices

 Another reason the spinoff sector is attractive to the little guy is because it offers an opportunity to buy shares of new companies whose capitalization rates are so small that the big Wall Street fund managers are not interested in them. Many mutual funds are, in fact, prohibited from taking large positions in companies whose market capitalization is less than about a billion dollars. Some of those shareholders don’t want to fool with ownership of the small new company, so they sell them. Many large hedge funds or mutual fund investors, for instance, may be prohibited from owning small-cap stocks because of their internal investment policies and guidelines. In that case, if they wind up with shares that were distributed to them as the result of a spinoff they will immediately dump all of them. That sudden surge in sales immediately after the spinoff stocks are issued can artificially depress share prices – and create a rare opportunity to buy at a deep discount. When stocks are not closely followed, the valuations are not always that accurate, either, resulting in many inefficiently priced small cap stocks that are there for the taking, with exceptional upside potential.

Real World Examples

Phoenix Companies, a large insurance conglomerate, spun away its subsidiary enterprise Virtus Investment Partners back in 2008, around the time the global financial markets imploded. Since then, the nimble and healthy little spinoff has followed the economic rebound in lockstep, nearly doubling its asset value and rewarding Virtus Investment Partners’ shareholders with stock price appreciation of more than 950%. Expedia spun off TripAdvisor and the new company’s stock catapulted more than 150% within 24 months. In 2007, Home Depot sold its industrial supply division known as HD Supply- that new company, which has more than 600 locations nationwide, registered a 14% increase in sales during its first year.

One of the biggest spinoffs of 2011 was when Motorola jettisoned Motorola Mobility. Less than nine months later Google purchased the new company at a 63% markup, while the unburdened parent company Motorola steadily rose in value – eventually delivering gains of more than 28%. Marathon Petroleum was spun off from Marathon Oil Corp. in 2011 and then raised its dividend by 25% – while its revenues grew by 6.5% the following year. Sara Lee spun off part of its food business operations as Hillshire Brands. Since the split in June 2012, Hillshire’s stock has risen more than 15%. Kraft Foods spun off its $36 billion global snack foods division into a new enterprise named Mondelez. Both stocks have risen in value by about 28% since the spin-off occurred. The point I’m trying to drive home is, spinoffs happen, they are highly profitable, and should be taken advantage of when possible.

Buy Quality and Beat the Market Averages

Beware of spinoffs that carry lots of debt, though, because they could be an accident waiting to happen. A good example of that happened in 2012 when Sears sent a spinoff packing, but first loaded it up with debt that the parent company desperately needed to remove from its balance sheets.  Instead, shop for companies with lots of cash, double-digit growth, and strong return on capital – just as you should do when picking any stock. You might do quite well, according to a study conducted at Penn State. Researchers there analyzed the results of spinoffs over a 25-year period and found that, on average, they outperformed the S&P 500 by approximately 10% per year for the first three years after the spinoff.

Tom Kerr writes for the blog at Comparecards.com in addition to others. He has been an avid writer for years, even winning awards for work he’s done.

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