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Stock Spinoffs: Fertile Ground For Value Investors

“You want to be well paid because you did your homework.” — Joel Greenblatt

Spinoffs represent fertile hunting grounds for the individual investor. Here’s what three great investors have to say about them:

In One Up on Wall Street, Peter Lynch states spinoffs often result in astoundingly lucrative investments. He says large parent companies don’t want to spinoff divisions and see them get into trouble because the embarrassing publicity would reflect back on the parent. The spinoffs normally have strong balance sheets and are well prepared to succeed. Lynch says spinoff companies are often misunderstood and get little attention from Wall Street. He advises investors to check and see a month or two after the spinoff if there is heavy insider buying among the new officers and directors — a sign they are true believers in the spinoff company’s prospects.

According to Seth Klarman in Margin of Safety, spinoffs often present attractive opportunities for value investors. They permit the parent to divest of businesses which no longer fit their strategic plans, are fairing poorly, or adversely influencing investor perceptions of the parent. He says the goal of the spinoff is to create parts with a combined market value greater than the present whole. Large institutional investors may deem the newly created entity too small to bother with and index funds will sell regardless of price if the spinoff is not a member of their assigned index. Klarman says spinoffs frequently go unnoticed by Wall Street analysts as they don’t usually follow them and many are small caps with low trading volume not likely to justify an analyst’s involvement.

In You Can Be A Stock Market Genius, Joel Greenblatt claims you could theoretically be making 20 percent annual returns in spinoffs. He addresses various reasons for spinoffs in the first place; unrelated businesses, separate out a ‘bad’ business, and getting value to shareholders for a business that can’t be easily sold. In addition, tax considerations may also influence a decision to spinoff versus an outright sale. Where’s our catalyst? According to Greenblatt, it’s built in. For instance, funds that can only own shares in companies included in the S&P 500 Index will be required to sell the spinoff. If an S&P 500 company spins off a division, Greenblatt states you can be pretty sure there will be a huge amount of indiscriminate selling. This initial excess supply has a predictable effect on the spinoff stocks price — it’s usually depressed.

A word of caution moving forward: John Mihaljevic states in Manual of Ideasopportunities in spinoffs may have diminished somewhat in the years following the publication of Joel Greenblatt’s book. I recently picked up shares in Ferrari NV (RACE) after they were spun off of Fiat. In addition to being a spinoff, Ferrari NV is also owned by Superinvestors Guy Spier and Mohnish Pabrai according to their latest SEC filings.

3 Jan 2017 UPDATE: My five stock spinoff portfolio returned 31% for 2016 versus the benchmark S&P 500 9.4%