EC The Top 3 Dividend Paying Spin-Off Stocks Today

This is a guest contribution by Rich Howe, CFA. Rich monitors the stock spin-off market at Stock Spin-Off Investing.

Legendary investor Peter Lynch, wrote in his investing classic One Up on Wall Street:

“Spin-offs often result in astoundingly lucrative investments.”

Mr. Lynch wrote his book back in 1989, but lucky for us, stock spin-offs continue to outperform the broader market today. Study after study confirms this stock market anomaly.

Select Stock Spin-off Studies Show Significant Outperformance

Spin-Off Studies

Links to the four studies from the image above are below:

  1. Corporate Spin-offs Beat the Market
  2. Do Spin-offs Create or Destroy Value?
  3. Global Spin-offs & The Hidden Value of Corporate Change
  4. Stock Spin-offs Continue to Outperform

The evidence shows that spin-offs outperform…But what exactly is a spin-off?

A spin-off occurs when a publicly traded company separates part of its business into a second public company and distributes its shares in the new business on a pro-rata basis to existing investors. Spin-offs occur because management thinks their business is undervalued by the market, and believes (with good reason) splitting the business up into a simpler structure will force investors to re-value the spin-off and parent more inline with comparable companies.  Let’s walk through an example to see how the spin-off process works in practice.

Spin-Off Example:Dover

On May 8, 2018, Dover (DOV), a Dividend King and conglomerate manufacturer of industrial products, spun off its energy business, Apergy(APY), into an independent public company and distributed its shares to existing Dover shareholders.

Dover Spin-Off

Source: Stock Spin-off Investing

The distribution ratio was 1:2 which means that for every 2 shares of Dover owned, an investor would receive 1 share in the new company, Apergy. Prior to the spin-off, assuming an investor owns 1,000 share of DOV. After the spin-off, that same investor would own 1000 shares of DOV, and also, 500 shares of APY.

Why Do Spin-Offs Outperform?

Usually stock spin-offs begin trading at a low valuation. This occurs for a couple reasons:

Reason 1:  Spin-offs are distributed to investors (not sold like in an IPO) and so there is very little publicity regarding the new company. Generally, no or few analyst cover the stock and so it is not marketed to institutional investors. Further, the spin-off is usually much smaller than the parent company, and oftentimes, institutional investors are prohibited from owning shares in the spin-off. Let me explain. If a large cap mutual fund manager owns a large cap company which distributes a small cap spin-off, that mutual fund manager’s investment mandate prevents the manager from holding the spin-off. For these reasons, many investors sell their shares in the spin-off regardless of price or underlying value.

Reason 2:  The management team of the new spin-off has very little incentive to promote the company initially. In fact, the management team is incentivize to not promote the stock. Why? Because management stock options are usually priced based on the first couple weeks of trading. The lower the stock trades initially, the greater value potential the options have.

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Disclaimer: Sure Dividend is published as an information service. It includes opinions as to buying, selling and holding various stocks and other securities. However, the publishers of Sure ...

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