Why do spin-offs tend to perform so well? There are many theories but the most reasonable seems to be that the management team is able to focus on what is best for that particular business only, not the parent company. In addition, they are compensated based on the operating results and stock performance of the business which often is far more motivating than simply being part of a huge conglomerate. Finally, the accounting for a single operation often tends to be far more transparent, making the financial metrics such as return on equity far more competitive with other enterprises in the industry. A candle company that is spun-off from a conglomerate and earns 100% on its tangible net property, plant and equipment with little or no debt is probably going to get a much higher price-to-earnings multiple on its own than the former behemoth of which it was a part.
It really is astounding to stop and consider how many spin-offs grow larger than the company out of which they came. One need only look at Tim Horton; a former operating subsidiary of Wendy’s. Following a partial spin-off and an initial public offering, the business now has a larger market capitalization than Wendy’s itself! Likewise, Sara Lee got rid of Coach, a maker of luxury handbags and formerly a tiny division of which Wall Street took little notice. At the time of this writing, Coach has a market capitalization of $18.5 billion while Sara Lee comes in at only $12.74 billion.
A Few Rules to Remember
There are a few things that you should always keep in mind.- Never, never, never – under any condition –risk more than you can afford simply for a few percentage points of extra return. The first rule of compounding is that you must have something to compound. Risking your entire retirement account on a penny stock is going to cause you to end up in the poorhouse and, worse yet, you will have lost the capital you contributed through your hard work; at least you could have blown it on a new television or a trip to Vegas!
