Investing in spinoffs can be very profitable. Studies, as well as the performance of exchange-traded funds and mutual funds that specialize in spinoffs, have shown that over time these companies beat the returns of the Standard & Poor's 500 Index.
Unshackled from large companies, spinoffs can set their own course toward growth. It makes sense then that small- and mid-cap companies have been shown to perform the best when spun off.
Timing such investments can be tricky, though. Often, the best time to buy shares in a spinoff is months after the company goes public, after the stock price has drifted lower.
At that point, the shares may have been put under pressure for reasons that have nothing to do with the merits of the company. Institutional investors will often dump a spinoff when it does not pay a dividend, or otherwise fails to meet the criteria for its portfolio.
Investors may also sell the shares because their stake in the spun-off company is too small to bother with, or the company doesn't fit their asset allocation, or it isn't included in an index. Demand for shares may be particularly weak for small- and mid-cap spinoffs, because those companies may not find an immediate following among analysts or investors. So a flurry of shares being sold into the market may find few ready buyers.
The hardest part of investing in spinoffs may be the time and energy it takes to find a worthy bet. The opportunities are limited. Even in 2014, a banner year, there were only 61 -- roughly twice the average.
And evaluating spinoffs, which can be less transparent than a typical public company, can also be a challenge. Spinoffs are something of an unknown set free, and they may still have some unpleasant tethers linking them to their ex-parents such as sharing potential liabilities.
There are also tax concerns. Spinoffs must be careful about making significant acquisitions, for example. The IRS may question the spinoff's tax-free status -- a big reason for doing a spinoff instead of selling a division -- if the agency believes a takeover was being financed with funds not paid to the government in taxes.
The three companies mentioned above are works in progress, but as a group have beaten the S&P in less than a year of independence. Lands' End is up 55% in nine months, Time is up 14% in seven months and Tribune is down 16% in five months.
The PayPal and Ferrari spinoffs will be multibillion-dollar deals expected to take place in the second half of the year. They will be joined by more than two dozen other spinoffs also expected this year. Among the better known ones on tap is the Hewlett-Packard (HPQ - Get Report) spinoff of its personal-computer and printing business, which will be known as HP Inc.
As an alternative to hunting and pecking or investing in big names for their names alone, investors can buy into ETFs and mutual funds that specialize in spinoffs.
The Guggenhim Spin-off ETF (CSD - Get Report) has been the star performer, easily swamping the S&P over the past three years. Two mutual funds -- Horizon Spin-Off and Corporate Restructuring Fund Class A (LSHAX - Get Report) and Keeley All Cap Value I (KACIX) -- also have beaten the S&P during that period.