I still remember the day my perspective on investing changed. I was watching CNBC, and Jim Cramer was passionately talking about spinoffs as hidden gems in the stock market. It caught my attention. Intrigued, I headed to the bookstore and started learning more, guided by insights from some of the senior investors of that time. But one day, I came across a study that completely shifted my approach to investing. It was the Penn State study on spinoffs, which revealed something quite surprising: spinoffs, as a group, consistently outperformed the broader market. This wasn’t just by a small margin—on average, spinoffs significantly beat the S&P 500 over multiple years. I decided to dive in and see what made these companies such a fertile ground for profit.
Insights from the Penn State Study
The Penn State study looked at spinoffs over a period of several decades and found that, on average, spun-off companies outperformed the market by about 10% per year over the first three years after becoming independent. Even more impressive, the parent companies also showed superior performance, often surpassing the market averages by several percentage points. This opened my eyes to the potential opportunities hidden within corporate restructuring that most investors simply weren't paying attention to.
Why Spinoffs Outperform
There are several reasons why spinoffs tend to outperform the broader market, and I’ve witnessed these factors at play multiple times throughout my career. For starters, focused management is a huge advantage. When a company spins off a division, it creates a new management team with a laser focus on the business at hand. Unlike the larger conglomerate, the newly formed company isn't distracted by other, unrelated operations. Management's goals are clear, and often they have significant equity stakes in the company, meaning they are motivated to drive value.
A recent example is GE HealthCare, which was spun off from General Electric in 2023. GE HealthCare inherited GE’s healthcare technology operations, allowing the parent company to focus on its core industrial and energy businesses. Initially, many investors were uncertain about GE HealthCare’s standalone prospects, and the stock faced some pressure. However, with a dedicated management team focusing solely on expanding its healthcare technology and services, GE HealthCare started gaining traction. Its stock began to recover as the market recognized its potential in healthcare innovation and diagnostics.
Indiscriminate Selling Creates Opportunities
One of the most valuable insights from the Penn State study was how indiscriminate selling creates opportunities for those willing to look beyond the surface. Institutional investors—like pension funds and mutual funds—often receive shares of spun-off companies, but these new entities may not fit their investment mandates. If a fund only invests in large-cap stocks, and a spun-off company is classified as a small or mid-cap, they have no choice but to sell, regardless of the company's prospects.
I remember when Trane Technologies, which was spun off from Ingersoll Rand in 2020. Trane Technologies emerged as a standalone entity focused on climate control and HVAC systems, distinct from Ingersoll Rand's industrial products. Initially, there was some uncertainty among investors, leading to pressure on the stock price. However, by zeroing in on climate innovation and sustainability, Trane Technologies established itself as a market leader, and investors who saw the value early were rewarded as the stock gained momentum.
The Numbers Speak for Themselves
The numbers behind spinoffs are compelling. According to the Penn State study, not only did spun-off companies outperform the market by an average of 10% annually, but the parent companies also tended to do well, beating the market by 6-7% on average. This dual outperformance makes spinoffs particularly attractive. You’re not just betting on the spun-off entity; the parent company, now more streamlined and focused, also has room to grow.
A more recent success story that embodies this dual outperformance is Carrier Global, spun off from United Technologies in 2020 as part of the Raytheon-UTC merger. Carrier, a leader in HVAC systems, saw its share price soar after the spinoff as it focused on its core business and implemented efficiency measures. Meanwhile, Raytheon Technologies, the parent company, also performed well by focusing on aerospace and defense. Both companies were able to thrive in their own specialized arenas, validating the findings of the Penn State study.
Focused Management and Better Incentives
Another key factor highlighted in the Penn State study is the role of incentives. The management teams of spun-off companies often receive equity-based compensation packages, giving them significant "skin in the game." This alignment of interests is crucial for driving performance. When I evaluated Organon, spun off from Merck in 2021, I noticed that its management team had substantial equity incentives. Organon was set up to focus on women’s health and biosimilars, areas that weren’t getting enough attention under Merck. As an independent entity, Organon’s leadership was highly motivated to drive growth in these sectors, and the market responded positively once they started executing on their plans.
Practical Takeaways for Investors
Look for Initial Selling Pressure: Spinoffs often experience a period of indiscriminate selling, which can create an attractive entry point for savvy investors. This is when you can buy shares at a discount, often below their intrinsic value.
Evaluate Management Incentives: Spinoffs with well-aligned management incentives are more likely to succeed. If management has a significant equity stake, they are more likely to be motivated to increase shareholder value.
Don’t Ignore the Parent Company: The parent company, post-spinoff, often becomes a more focused and efficient operation. The Penn State study shows that parent companies can also outperform, making them a great addition to your watchlist.
Conclusion
The Penn State study on spinoffs vs. market performance has had a profound impact on my investment strategy. It taught me to look beyond the noise and recognize the potential value in corporate restructuring. Spinoffs aren’t always glamorous, but they have consistently outperformed the market, often by substantial margins. By focusing on the fundamentals, recognizing the opportunities presented by indiscriminate selling, and paying close attention to management incentives, you can uncover investments that others might overlook. In my experience, the value in spinoffs is there for those willing to look—often hiding in plain sight.