“The facts are overwhelming. Stocks of spinoff companies, and even shares of the parent companies that do the spinning off, significantly and consistently outperform the market averages.” – from You Too Can Be a Stock Market Genius by Joel Greenblatt
- In simplest terms, a stock spinoff is a tax-free divestiture of one company by another, which results in the shareholder of the original company now owning shares of both. The net effect is that the separate companies are now freed up to focus on their respective core businesses.
- Per a Deloitte study, conglomerates tend to be undervalued, likely because investors are reluctant to assign premium valuations to many-faceted corporations with fewer synergies than more streamlined and focused businesses.
- The result of the spinoff is that both the “spinner” and the “spun” companies appear more transparent in their operations and business results, and thus are more attractive to would-be investors.
- The idea that streamlining unlocks value for both parties seems to be borne out in the actual returns.
- Investing in spinoffs, however, may not be as simple as the index returns suggest. For one thing, spun-off shares tend to take a tumble in the days and weeks after being spun, which could lead many investors to sell these unfamiliar shares out of their portfolio.
- Although investors might think this initial weakness is signaling dire prospects for the new company, the reality is that the weakness in the new shares has little or nothing to do with the fundamentals of the company. Rather, the decline is due to reasons that are mostly technical. Credit Suisse explains that the new shares may not meet the criteria necessary to remain in the index or portfolio that holds the parent company, and so forced selling occurs. Eventually, the forced selling subsides, and the shares recover.
- Spinoffs are not without risks, though, and they are by no means universally successful. In truth, some spinoffs can be the result of a parent company wanting to jettison unwanted liabilities or lagging businesses, and for these reasons, spinoffs such as these, which are now cut off from the resources of the larger, perhaps more diversified parent firm, can be especially vulnerable. As always, investors need to take these factors into consideration when entertaining a prospective investment.