May 29, 2015
The 'Black Sheep' Stocks That Beat
The Market 4-To-1
By Nathan Slaughter
You may or may not have heard of renowned money manager Joel Greenblatt.
Over an illustrious career spanning more than twenty years, the Gotham Capital hedge fund manager racked up annualized returns of 40%, eclipsing the success of even his mentor, Warren Buffett.
Investors who were on board with Greenblatt for his entire tenure at Gotham would have seen a $10,000 investment balloon to more than $8 million, earning 800 times their initial stake.
And his remarkable track record didn't rely on luck. Rather, he profited because of his intense focus on a unique group of companies sharing one common trait.
Industry leaders like American Express, Liberty Media, Allstate, Expedia and Kraft Foods all carry this trait. And they each helped Greenblatt and fellow investors make millions...
These companies are just a few of a long list of spin-offs that all once belonged to larger parent companies.
And they all flourished after leaving the nest.
Take spin-off biopharmaceutical maker AbbVie (Nasdaq: ABBV) for example. Since officially leaving its parent company, Abbott Laboratories, in January 2013, ABBV has risen more than 100%... beating the market by nearly 60%.
And here's another example. Just over two years ago, ConocoPhillips separated its upstream oil and gas production from its downstream refining operations to create two distinct companies. Shares of Phillips 66 (NYSE: PSX) were distributed to investors of ConocoPhillips and have since gone on to nearly triple in value, while the S&P 500 merely gained about 52%.
One of the most famous studies was conducted by consulting firm McKinsey in 1999. McKinsey reviewed 168 restructurings over a 10-year period and found that shares of spin-offs produced annualized gains of 27% in the 24 months following separation, versus a 17% gain for the S&P 500.
That performance could have turned a $10,000 investment into more than $109,000 over 10 years.
Had you put that same amount into an S&P 500 index fund, you would have only $48,000. And that's taking the good with the bad -- without any effort made to identify the best-positioned spin-offs offering the most potential.
Skeptics might say that the results are skewed by a handful of big winners. But the facts say otherwise. A study between 2003 and 2006 found that two-thirds of all spin-offs went on to outperform the market.
In a separate example, between 2003 and 2014, Bloomberg's Spin-Off Index squarely beat the market
That's not bad for businesses that were essentially the "black sheep" of their parent companies. But there are several factors behind why spin-offs perform so well after separation.
You see, spin-offs happen for a number of reasons... Sometimes it's to cut loose parts of a business after a big acquisition in order to satisfy anti-trust requirements. Other times it's to resolve friction or conflicts of interest between a subsidiary and parent.
But the most successful spin-offs happen when a parent company wants to simply un-tether a fast-growing business that needs to be set free.
No matter how bright its prospects, smaller subsidiaries or business units tend to get lost in the shadow of the parent. Because their financial contribution is often buried on the income statement by a much larger business parent, they often don't get the full recognition they deserve. But once a growing arm of a company is spun off, the market can finally appreciate its true value.
Spin-offs also tend to be overachievers, if for no other reason than the new firm's leaders are suddenly free from bureaucracy and find themselves sitting on a bundle in stock options in the newly-formed company -- which provide a compelling incentive to grow the company.
So how can investors harness the power of spin-off companies?
Well, one of the biggest winners I hold in my premium newsletter, Total Yield, is a classic spinoff.
By combining the advantages of the Internet and a booming Chinese middle class, this company has more than quintupled the S&P since being spun off in 2006.
And the effects of these catalysts are only just starting to be felt. As of 2014, only about 15% of the Chinese market used this company's services. But the market for this service in China is projected to grow by nearly 400% to $75 billion in 2017.
Like other stocks in my Total Yield portfolio, this one has been buying back massive amounts of shares, leading to a "total" yield far higher than what you'll find on popular financial sites (you can learn more about these "hidden" yields here).
Besides this company, there are several funds created for the sole purpose of identifying the hidden opportunity in spin-offs. One of the oldest is the
First Investors Special Situations Fund (FISSX). This fund has chalked up an annualized return of 9.7% over the past decade, outrunning the S&P 500 by more than 150 basis points per year.
Regardless of where you choose to find them, history is filled with examples of newly-listed stocks that shot higher in the weeks and months after being spun off from a parent company. And with a track record of beating the S&P 500 index by
four-to-one, these are companies worth looking at owning for your own portfolio.
Chief Investment Strategist
P.S. If you'd like more insight and actionable advice from Nathan, consider a
risk-free subscription to his premium advisory, Total Yield. Sign up for
Total Yield here and receive a free report on what Nathan calls the 'Total Yield Aristocrats' -- an elite group of companies that have not only increased dividends for more than 25 years, but have also returned over 344% since 2004, more than double the S&P.
Click here to learn more.