-First of all, what is a spinoff?
A spinoff is the result when a company takes a part of its business and separates it and forms a new, independent company whose shares usually get distributed to the existing shareholders of the parent company.
-Why can spinoffs be so profitable?
Some of the reasons are:
1) Existing shareholders of the parent company are sometimes not interested in owning shares of the spinoff, especially if the spinoff is in a business unrelated to the parent company's business, or if the spinoff company trades on a different exchange, or if the spinoff has a much smaller market cap than the parent company, in which case index funds would be required to sell the spinoff. This creates enormous selling pressure on the stock and drives the price down considerably, making the spinoff mispriced/undervalued.
2) Sometimes, two business separated are worth a lot more than when they're together. Essentially, the whole is not more than the sum of its parts.
3) Sometimes, companies have a part of their business that is experiencing much higher growth than other parts of the company. A spinoff can be an excellent way to capture the value of the high-growth business.
4) With a newly created company, the management has a lot more flexibility.
A study completed at Penn State University found that stocks of companies that had been spun off outperformed their industry peers and the S&P 500 by about 10% per year in their first 3 years after being spun off. -- Remember, that's just for the average spinoff! If you can pick your spots, and invest in only the good ones, you can crush the market.
In my next post, I'll show you some more evidence of the outperformance of spinoff stocks, including some actual spinoff stocks.