On average, the stock market marches higher at a rate of roughly 10% per year.
That is more than enough to build significant wealth over time.
But I enjoy a challenge…
And what I enjoy even more than the stock market’s long march higher is beating the market.
To do that, you have to try harder and use different tools in your investing toolkit…
Investing in spinoffs is one strategy that has been proven over time to produce market-beating returns.
A spinoff happens when a parent company “spins off” one subsidiary or business unit into a stand-alone public company.
When the spinoff occurs, the shareholders of the parent company receive shares of this newly spun-off entity.
Companies spin off subsidiaries for a couple of reasons…
One is to rid the parent company of a noncore business so that it can focus on what it does best.
Another is to create value for shareholders. Management may believe that the subsidiary business will receive a better valuation as a standalone company.
Our opportunity as investors tends to arrive in the weeks and months immediately after the spinoff occurs.
Often, many institutional investors who receive shares of the spinoff business don’t want them.
They invested in the parent company, not this smaller subsidiary.
Sometimes the institutional investors aren’t even allowed to own shares of the spinoff company because their investing guidelines don’t let them own stocks under a certain size.
That is especially true when it is an exchange-traded fund (ETF) or index fund receiving the shares of the spinoff company.
The smaller spinoff company almost always won’t be a part of the specific index of stocks that the ETF or index fund is meant to track, so the spinoff company can’t be held.
The result of all of this is that the shares of the spinoff company often get sold off aggressively – not because of poor business performance, mind you, but just as a function of being a spinoff.
Anytime widespread selling of a company’s shares occurs due to something other than underlying business performance, that is the sound of opportunity knocking.
This creates obvious potential for an investor who is paying attention to move in and scoop up shares of an undervalued spinoff company.
And the historical data supports the theory…
Purdue University conducted a comprehensive study of spinoffs over the 36-year period between January 1965 and December 2000.
The study looked at 311 different spinoffs and compared how those companies performed with how businesses of a similar size performed in the same sector.
The results were compelling…
In just the first 12 months following their spinoffs, these 311 companies outperformed their benchmark companies by a whopping 20%.
That isn’t modest outperformance – that is outperformance by a huge margin.
Another spinoff study in 1988 at Penn State University drew similar conclusions.
That Penn State study found that the shares of spinoff companies outperformed both their peers and the overall market by 10% annually in their first three years.
Again, that is a wide level of outperformance.
With data like that, you can bet I’m constantly watching companies that are spinning out subsidiaries.
The next time I see one that looks especially interesting, I’ll share it with you.