A spin off consists of a distribution of shares of a subsidiary of an existing publicly traded corporation to the current shareholders resulting in two separate publicly traded securities.  Larger spun off companies often result from breaking up conglomerates formed over the years to allow Wall Street to value the businesses individually.  Recent prominent spin-offs with these motivations include the breakup of 21st Century Fox into Fox (FOX ) and News Corporation (NWSA ), Dean Foods spinoff of White Wave Foods (WWAV ), and Sears spinoffs of Sears Canada (SCC.TO ). Sears Home and Outlet Stores (SHOS ), and Orchard Supply Hardware (OSH ).

Click to Enlarge

Spinoffs are popular with corporate managements again after nearly halting during the financial crisis.  Theres been 13 spinoffs in the U.S. to date in 2013 with 16 more scheduled for the 2nd half of the year.  Year 2012 had 23 spins, 2011 had 22, and 2010 just 10.  Spinoffs are popular with investors again too.  The chart above shows the Guggenheim Spinoff ETF (CSD ) plotted against the major indexes for the last two years.  The spinoff ETF tracks an index consisting of major spinoff companies that occurred within the last 30 months.  Below are the returns of the Guggenheim Spinoff ETF for the past two years.  The Guggenheim Spinoff ETF has crushed all the major indexes sporting a return of 57.71% nearly doubling the return of the next highest index (Nasdaq +29.41%).

Guggenheim Spinoff ETF performance vs. indexes for trailing two years (July 12, 2011 to July 12, 2013)

The trailing five-year period  that includes the financial crisis meltdown also shows significant out performance with the spinoff ETF returning 104.69% after fees (0.60% a year) .  The  best-performing index (Nasdaq) returned 62.69% in the same period.

Guggenheim Spinoff ETF vs indexes for trailing five years (July 11 2008 to July 12 2013)

None of this is surprising.  A number of academic studies have documented the outperformance of spinoffs over different 10 year spans.  Value investors are quite aware too.  Seth Klarman points to spinoffs as an often mispriced security in his famous book Margin of Safety published in the early 90s .  At least that is what I understand as I cant get my hands on one of the just 5000 printed copies that sell used for $1200.  Joel Greenblatts 1997  You Can Be a Stock Market Genius also spends nearly half its pages extolling the virtues of spinoffs.   He suggests you just buy them all if you dont know much about security analysis, but also gives specific advice for picking the winners from the spinoff class if you do know something or care to learn.  And this book sold well more than 5000 copies and was and is widely available in libraries.  The Guggenheim ETF buys all the major ones so Mr. Greenblatts advice to just buy them all seems like it was worth the $10 for the book.  So the academics have written papers and the best value investors have written books.  What continues to amaze  is that the outperformance has gone on for decades now and investors still apparently dont seem to catch on.

So should you just buy the Guggenheim ETF and go to the beach?  No for three reasons.  First why pay 0.6% annual fees to own 40 stocks that you could just buy yourself for $10 a trade.  Why do mutual funds even exist anymore?  So should you just buy all the major spinoffs in your brokerage account and go to the beach?  No for the 2nd reason.  Momentum investors are real good at finding ETFs that are going up.  Note on the Guggenheim chart above that the spinoffs have run like crazy since last Fall.  I wonder if the momentum investors arent chasing the spinoff stocks up already.  If not now, someday they will chase them up to silly valuations where theyre liable to stay until they underperform for 10 years and they all lose interest.  And the third reason not to buy the ETF and go to the beach?  Because you can probably do a lot better in the spinoffs that the ETF doesnt buy;  that is the microcap spinoffs that are too illiquid for the ETF to include.

So why are spinoffs often attractive investments?  Theres a number of reasons many of which are cited by Mr. Greenblatt and Ill add some of my own.

1.  Indiscriminate selling.  Parent shareholders dont buy these spinoffs they just show up in their account.  Some of these shareholders were index funds that must sell.  Others are large cap funds that arent allowed to own a small-cap so they sell.  Others are individuals or managers that bought the parent for a specific reason and have no reason to own the spinoff.

2.  Limited analyst coverage and management communication:   Analysts may be slow to pick up coverage and management doesnt want to communicate until their stock options are priced.  No information coupled with indiscriminate selling makes for a low initial stock price.

3.  Incentivized management :  As part of a larger organization, subsidiary performance may not have affected the stock price of the parent much.  As a separate organization, managers now have options on their own stock price so they have incentives to deliver.

4.  Entrepreneurial spirit.  As a smaller organization freed from large company bureaucracy and a future that depends only on the new companys performance employees are motivated to improve financial performance.

5.  Opportunities that are not understood by investors:  Spinning a subsidiary off is an expensive undertaking requiring investment banking fees that are significant.  The company was spun off for a reason especially if its a microcap.  Theres some opportunity in many cases that investors wont initially fully understand resulting in a depressed stock price until the advantages of the spinoff become evident.

6.  Buyouts:  Many spinoffs are acquired a few years later at a premium.  Perhaps a sale was desired all along but a spinoff was elected rather than a subsidiary sale to avoid double taxation (corporate tax on subsidiary sale followed by tax on a dividend).  Most spin-offs are tax free distributions but the distribution becomes taxable if the spinoff is bought within two years of the spin.

I wont pretend that I have a lot to add to the fine work of Joel Greenblatt.  Read that Stock Market Genius book if you want advice on investing in spinoffs.  I do hope to add just a little content  that you may find of value in a coming article.  My 15 years of experience investing in these things is a little different than Mr. Greenblatts.  For many of those years I was managing only my own meager assets.  That means I could and did buy the tiniest ones.  Spinning off tiny little microcaps is done for different reasons than breaking apart multi-billion dollar conglomerates.  No sane manager would break apart a collection of businesses into micro-cap sized chunks to get a better valuation.  Theres other reasons to spin off microcaps and its important for investors to understand why these transactions are happening.  The internet didnt really exist in 1997 either, so Mr. Greenblatts recommended research methods to find spinoffs was to read a lot and occasionally youll come across an article about one.  Obviously theres better sources today, although reading a lot is still important for investors.  Ill also reiterate some of Joels admonitions based on his experience with some experiences of my own.

The MicroCapClub (mc2)  is an exclusive forum for experienced microcap investors focused on microcap companies (sub $300m market cap). The MicroCapClub was created to be a platform for experienced microcap investors to share and discuss stock ideas. Our goal at MicroCapClub.com  is quality membership, quality stocks, and quality content.  If you are an experienced microcap investor, feel free to Apply today .