Spin-offs outperform

You can beat the Street. At a time when many professional investors lament that the proliferation of exchange-traded funds (ETFs) and widespread use of screening techniques have made it harder to find bargains in the stock market, one simple investing approach continues to outperform: spin-offs.

Spin-offs have long been a fruitful investment area; a number of academic studies show that they historically have generated far better returns than the overall stock market. A spin-off occurs when a corporation issues stock in a subsidiary to its shareholders to create a new public company. A related corporate event is an IPO carve-out, through which a company sells the public a stake in a unit, while retaining the rest of the division. Sometimes, the remainder is later distributed to shareholders.

The Bloomberg U.S. Spin-Off Index has surged 18.9% in the first seven months of 2017. The S&P 500 Index has increased 11.6% in that same period (see “Beating the benchmark,” below). The spin index generated a total return of 182% in the past five years (versus 99% for the S&P 500). The Bloomberg US Spin-Off Index has produced a total return of 867% since its Dec. 31, 2002 inception. The S&P 500 generated a total return of 278.5% over the same time frame.

Why do spin-offs outstrip the market? Spin-offs benefit from greater management focus and accountability as stand-alone public companies versus when they were part of larger enterprises. The rational for spin-offs varies. Some companies wish to get rid of a weak or low-margin division that is detracting attention from the parent. Other companies seek to highlight the attributes of a desirable unit whose full value may not be reflected in the parent’s stock price. There also is pressure on management from the growing number of activist investors, whose prescription for a lagging stock often is a breakup. Last year, there were 35 total spin-offs, with a total market value of $100 billion (see “2016 Spin-Off form,” below).