Exploring Spin Offs

Exploring Spin offs

Spin off companies appear to be a place where one can consistently beat the S&P 500.  This post will explore this possible investment closer than previous posts.  If you would like to see my perspective on a spin off that occurred recently you can check out the posts I wrote on the Conduent spin off that occurred earlier this year.  Full disclosure, as of this writing I currently have 100 shares of Conduent and five long term options in Conduent and Xerox set to expire in 2019.

Corporate spin off opportunity from Xerox: Conduent

“Carefully study spin offs” – Charlie Munger

Risks

The risks associated with spin offs are numerous, so before a reader immediately goes out and buys every spin off they can find, some words of caution:

  1. A Deloitte study found that 4 out of 10 spin off companies do not generate a positive return in their first 12 months of trading.
  2. The same study found that the bottom quartile returned -39% over the first year.

You can find the Deloitte study by following this link.

Rewards

The return associated with spin offs is apparent in the Bloomberg Spinoff Index which from 2003 to 2016 returned approximately 15.58% while the S&P500 returned 8.88%!

Reasons Spin offs remain a good place to look for deals

  1. In a world of increasing index investing, many spin offs will be beaten down by institutions selling the shares of the new company outright because it will not be in the index.
  2. Institutions may also find that the recent spin off does not meet their investment expectations (like size or leverage amount) and they will again immediately dump the shares without considering the value of the investment.
  3. Sometimes these smaller companies demonstrate a new, previously undiscovered business opportunity.
  4. Investors often are wary (or haven’t heard) of these companies because many of them are not followed by analysts until after a few months of independence.

Conclusion

With a consistent way to outperform the S&P500, this seems to be a place I want to be in the stock market.  Next week HPE will be spinning off a portion of its business, as a current investor in HPE I will be looking at this spin off with great interest.

Stock Investment Risk

This post will be focused on understanding the risks associated with investing in the stock market.

Before you entrust your investments into any field, acquaint yourself with the dangers which may befall your principal.

-Arkad, The Richest Man in Babylon, p34.

What losses do we encounter when investing in stocks?

Although this is not an exhaustive list, it should acquaint us with the risks associated with investing:

1. Principal losses

Principal (not principle) is the term used to identify the initial money used in an investment. The investment industry seems to leave this concept on the side when they attempt to get us the lay investor to place money into their investment accounts. Stock investing has some of the least protection to the original principal. Dangers to your original investment include the possibility that the company you invest with is forced into bankruptcy. This is no small matter for the investor because if a bankrupt company’s assets are liquidated, the proceeds are first used to pay any debt obligations the company had.

Complete principal loss is fortunately not too common in the stock market but it does happen, some examples that come to mind are Enron, WorldCom, Lehman Brothers, General Motors and recently Hanjin Shipping. Unfortunately, some companies don’t declare bankruptcy but still lose a lot of their value for their investors and this can be more common. Companies that find themselves in this later category should make any investor leary of stock investing: Nokia  which dropped from a high on 04/01/2000 of $50.38 to $4.45 on 11/01/2016 and Xerox heading from a high of $59.06 01/01/1999 (party likes its 1999 anyone?) to $9.78 on November 1st. This information is not shared to scare us away from investing in the market or even investing in individual stocks-it is shared to illustrate the possibility and potential scope of stock losses.

2. Opportunity losses

The other side of potential losses is the main selling point of the investment community: opportunity loss. The potential to miss out on the rise of the stock market as it has proceeded to increase in value for the majority of our lives is very alluring. For example, the Dow Jones Industrial Average has  increased approximately three times its value on 12/1/1996-this includes the losses incurred in the financial crisis and the dot com bubble. This is even more pronounced when we consider the price of Google since its initial public offering. The company opened at $50.05 on 8/1/2004 and on 11/1/2016 it closed at $775.97. This would mean that investing $10,000 in August with Google would be worth over $155,000 today. A quick analysis of Netflix, Facebook, and Amazon would garner similar results. No wonder this is such a great sales technique for the would be investor.

Other opportunities should also be considered. Investing your hard earned money with the stock market may prevent you from purchasing other sound investments like real estate or owning a business. The money placed in the market should create returns that are superior to these and other investments.

3. Time losses

The last consideration of potential loss in the stock market is time loss. Investing in the market when principal is lost can cause us to worry often about what the future holds. This may be the most painful loss to consider because it could include lost time with family and friends and a loss of health due to the additional stress it can cause. In my opinion, this is one loss that can make investing not worth it.

Although this list is not exhaustive, it should help us understand the risks that we face when considering investing in the stock market. What other risks might an investor need to consider in your opinion? I appreciate your comments.