When stock markets are bullish, that usually means that corporate earnings are also very positive. And when that occurs, companies often consider selling off parts of their organizations, frequently in the form of spin-offs. A spin-off is simply when a division or subsidiary is separated from its parent company, and begins its life as an independent, spin-off stock.
Since 1990, corporations have been spinning off subsidiaries at an average rate of about 50 per year. Those statistics included quite a few years of very bullish markets. In 2017, there were 19 spin-offs, and 29 last year. So far in 2019, 30 spin-offs have been announced, and as long as the market remains bullish, we should see that number increase. The sectors for the spin-offs are very broad, with the most reported in the healthcare, automobile/transportation, and entertainment arenas.
And the bottom line of all this spinning off is very good for investors: a plethora of studies have concluded that spin-off stocks average a return that is 10% higher than the broad indices. As of July, last year, the Bloomberg U.S. Spin-Off Index had risen more than 22% and had beat the S&P 500 Index by 13%. From 2002 to 2017, the index gained 999.4%, compared to the 203.9% posted by the S&P 500 Index during that same period.
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Unless you majored in finance or are a stock broker yourself, you may not feel confident enough to invest on your own.
This free report aims to give you the confidence to dive right into the stock market.
Download it today, FREE when you sign up for our complimentary Cabot Wealth Daily advisory!
Spin-off stocks are so popular, there’s even an exchange-traded fund, Invesco S&P Spin-Off ETF (CSD), that investors can buy to easily get in on the action. That ETF has gained 24% in the past 52 weeks.
Not All Spin-Offs are Created Equal
However, just like with any equity, investors must approach spin-offs with an analytical eye. Many spin-offs are winners, but others aren’t.
First, you need to determine why the spin-off is occurring.
There are a couple of good reasons:
- Activist investors are urging companies to unload non-related business divisions that they believe are holding a company back.
- Spin-offs can unlock value in a company, making the sum of the parts greater than the whole. They often allow management to bring laser focus on individual units that have gotten lost in the shuffle of the conglomerate, giving them a chance to grow into viable businesses. And that can provide opportunities for investors to buy bargain-priced companies with fabulous potential.
There are several catalysts that boost spin-off prices:
- Management is more incentivized by way of stock options and shares.
- The company’s leaders have more leeway to cost-cut and to begin new enterprises.
- Focus on a pure-play company can uncover significant investment potential, as they are easier for investors to understand.
Spin-off stocks are often undervalued because investors may sell the new company if it doesn’t fit their particular investment strategies or disciplines. And often—due to their mandates for investing in stocks of specific market caps—index funds often retain the parent shares and dump the spin-off, which can undervalue the spun-off stock by as much as 20%.
But investors need to know that there’s no guarantee that the spin-off will blossom. The spin-off companies tend to be higher beta stocks that underperform in weak markets and outperform in strong markets, making them more volatile, and better in bull markets than in a bear environment.
Also, many spin-off stocks sell off right after the separation. But that discontinuity generally goes away over the longer term.
How to Evaluate Spin-Off Stocks
Now that we know that spin-offs can be profitable, how do you know which ones in which to invest?
Here are a few questions to ask when analyzing a spin-off:
- Are the interests of the managers of the spin-off aligned with yours? Are they incentivized through stock ownership to continue focusing on enhancing shareholder value?
- What’s the reason for the spin-off? Evaluate the company’s debt and assets to make sure the ‘bad stuff’ isn’t being dumped into the new company.
- Look at operating income compared to net working capital, less cash to see if the spin-off has strategic advantages.
- Valuation, valuation, valuation—is the spin-off headed for the starting gate with a reasonable valuation? You may have to do a little digging here, to compare the spin-off’s business with its peers to see if a valuation advantage exists.
Fortunately, the Securities & Exchange Commission requires that companies planning to separate file pro-forma statements so investors can take a look-see at what the spun-off company might look like. Those are called 10-12B forms.
You can start your search here: https://www.investopedia.com/terms/s/sec-form-f-10-12b.asp. The SEC also provides a list of upcoming spin-offs: https://www.sec.gov/cgi-bin/srch-edgar?text=form-type+%3D+10-12b+OR+form-type%3D10-12b%2Fa&first=2009&mode=Simple
So how does one invest in spin-offs? There are two alternatives: invest in a spin-off exchange-traded fund (ETF) like the Invesco Spin-Off ETF or invest in a stock once it announces an upcoming spin-off.
The next question is, how do you find spin-off stocks? Well, you can search through the 10-12B forms on the Securities and Exchange Commission (SEC) site. Or you can look at any number of websites, including https://www.stockspin-offs.com/upcoming-spin-offs/ or https://longrunplan.com/spin-off/.
I recently ran a search on upcoming spin-offs to see which companies looked interesting from an investment standpoint. Of the 30 deals I researched, I found three spin-off stocks that look interesting.
3 Future Spin-Off Stocks to Consider
Danaher Corporation (DHR) designs, manufactures, and markets professional, medical, industrial, and commercial products and services worldwide. Coverage of the company’s shares was just initiated at Needham with a ‘Buy’ rating.
The company beat earnings estimates for its fourth quarter, by 0.8%—its 12th consecutive quarter surpassing Wall Street’s forecasts.
Danaher will spin off its Dental segment in the second half of 2019.
Smiths Group plc (SMGZY) is a global technology company severing the medical technology, security and defense, general industrial, oil and gas, and space and commercial aerospace markets.
Smiths Group has seen strong improvement in earnings, and has reasonable P/E and P/B ratios.
After a failed merger with ICU Medical, the company will spin off its medical devices unit, Smiths Medical, sometime this year, so that it can focus on its industrial technology business. The medical devices unit’s primary products are in the infusion therapy, vascular access, vital care, and specialty care areas.
Eli Lilly and Company (LLY) is a worldwide manufacturer of pharmaceutical products through two segments, Human Pharmaceutical Products and Animal Health Products. The company plans to spin off its Elanco animal health business this year, and expects to raise up to $1.45 billion in its initial public offering.
Coverage of the shares was just initiated at UBS, with a ‘Buy’ rating.
The company is due to release earnings this week and the shares have been on an upward trend in anticipation. Jim Cramer recently recommended the shares with a price target of $135.
No exact dates have been set for these spin-offs as of yet, but the parent company stocks all look fundamentally and technically attractive. So, if you have a few extra dollars and want to try your investment hand at spin-offs, these three spin-off stocks might be a good place to begin.
Nancy Zambell, Editor of Wall Street’s Best Investments, has spent 30 years helping investors navigate the minefields of the financial industry. Nancy scours more than 200 advisories and research reports to select the top recommendations, which she collects for you in this easy-to-read digest.Learn More