Can spin-offs make you a millionaire?

The Motley Fool
Mining truck
Mining truck

While many investors gravitate towards volatile tech, oil or gas stocks in an effort to secure early retirement, far fewer take an interest in spin-offs - companies created through the distribution of shares by a parent business to existing holders.

Spin-offs can happen for various reasons. A business may wish to streamline its operations, for example. Setting up a new company allows both the existing and new management teams the opportunity to focus on a more limited range of products or services, hopefully to the benefit of shareholders.

Sometimes, a company may feel that one or some of its component parts aren't properly valued. Creating a spin-off should encourage the market to re-evaluate these assets to the point where they're often worth more as separate entities. On other occasions, companies might want to create a spin-off to side-step regulatory hurdles.

Why should investors care?

Perhaps one of the most compelling benefits for existing investors is that both a parent company and its spin-off tend to perform better once the separation is complete -- particularly the latter.

But while creating a new company may make sound business sense, there are also benefits for prospective investors. Given that many existing holders would prefer to keep their capital concentrated in the parent business, shares in the spin-off are often quickly jettisoned from portfolios.

This tendency to sell isn't limited to private investors. Fund managers will also offload shares in the newly-created company, particularly if it doesn't meet certain criteria or the objectives they're required to work towards. Since the spinoff is usually a lot smaller than its parent company, many are forced to sell for reasons of size, even if they believe that prospects for the former are good.

Of course, all this downward pressure presents a wonderful buying opportunity for those wishing to invest for the medium-to-long term.

Got any evidence?

Yes, actually. In 2015, FTSE 100 constituent BHP Billiton created South 32 -- the base metal and coal mining company with assets in Australia, Southern Africa and South America.

When shares entered the market in May, they began to fall almost immediately, partly due to the negative sentiment surrounding resources stocks at the time, but also because many investors wished to relinquish their minor holdings. Since reaching a low of 42.5p back in January 2016 however, shares have rallied to as high as 178p. That's a rise of almost 320% in 14 months. Meanwhile, BHP's shares have climbed 'only' 123%.

Indivior - the specialist pharmaceutical company focused on treating addiction - is another example of a successful spin-off. Originally a part of consumer goods giant, Reckitt Benckiser, the £2.4bn cap was set up back in 2014 and now occupies a space in the FTSE 250 index.

After hitting a low of 130p just over a year ago, shares in Indivior have since rocketed by 158% to 335p. For comparison, shares in Reckitt are up around 11% over the same period.

Of course, there are many caveats here. For one, shares of spin-off companies have a tendency to be more volatile than those of their parents. Moreover, macroeconomic or political events can impact on sentiment towards all stocks, including promising offshoots. As such, it always makes sense to position your portfolio in such a way that your financial goals are not dependent on any one company or industry remaining resilient.

Make no mistake

While they could certainly assist investors in making a million, assuming that all spin-offs automatically lead to riches would be a mistake.

If you're keen to avoid expensive blunders in your investing career then I strongly encourage you to spend a few minutes reading a special report from the Motley Fool. They've asked the best in the business to identify the top mistakes investors make. Do you make these yourself? There's only one way to find out.

Click here for a copy of their report. It's completely FREE and without obligation.

Paul Summers has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.