A Positive Spin on Spinoffs

After Agilent Technologies spun off its semiconductor business last year, shares in the new firm, Verigy, soared. The stock is up 55% since the spinoff, versus 9% for Standard & Poor's 500-stock index. Another spinoff, Sally Beauty Holdings, is up 20% since Alberto-Culver set it free, compared with 7% for the S&P 500. This spring, Altria Group split off Kraft Foods amid much fanfare but decidedly mixed reviews. Even so, Kraft has been neck-and-neck with the S&P.

Detect a pattern? It's no fluke -- studies have shown that spinoffs are very good investments. Lehman Brothers found that spinoffs beat the S&P 500 by an average of 18 percentage points in their first two years as independent companies. A few theories explain the success. Managers of the new company are often motivated by incentives tied directly to its performance, in a way that was impossible in a bigger company. Also, the new stock often trades at a discount early on because investors who never meant to own it sell their shares, and eager buyers don't arrive until there's analyst coverage and a track record. Finally, the market often assigns a higher value to easy-to-understand companies.

Spinoffs can take a couple of different paths. The parent company may distribute shares as a dividend, in most cases tax-free for both the company and the investors. Or a company may sell stock in the subsidiary via an initial public offering. (By the way, parent companies also tend to beat the market in the months immediately before and after a spinoff. Watch Halliburton [symbol HAL] now that it has shed its KBR unit, a politically charged defense contractor.)

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The easiest way to invest in spinoffs is through a new exchange-traded fund, Claymore/Clear Spin-Off (CSD), up 17% since its launch last December. The fund holds about 40 stocks. To employ a more targeted approach takes homework, such as scouring the Securities and Exchange Commission's electronic database (for help, check out www.gemfinder.com). For $69 a month, you can subscribe to Spinoff & Reorg Profiles (www.spinoffprofiles.com).

Spinoff editor William Mitchell says stock in Idearc (IAR), the telephone-directory business that Verizon spun off last fall at $26.25 a share, is still a bargain at $36. Spin-Off Advisors, a Chicago research firm for professional investors, thinks Metavante, a payment processor for financial firms, will be a good value when bank Marshall & Ilsley (MI, $49) spins it off later this year. Better yet, buy the bank now and get both.

Anne Kates Smith brings Wall Street to Main Street, with decades of experience covering investments and personal finance for real people trying to navigate fast-changing markets, preserve financial security or plan for the future. She oversees the magazine's investing coverage, authors Kiplinger’s biannual stock-market outlooks and writes the "Your Mind and Your Money" column, a take on behavioral finance and how investors can get out of their own way. Smith began her journalism career as a writer and columnist for USA Today. Prior to joining Kiplinger, she was a senior editor at U.S. News & World Report and a contributing columnist for TheStreet. Smith is a graduate of St. John's College in Annapolis, Md., the third-oldest college in America.