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These 'Black Sheep' Stocks Beat The Market 4-to-1

Wednesday, June 25, 2014 - 11:30am

You may or may not have heard of renowned money manager Joel Greenblatt.

Over an illustrious career spanning more than twenty years, the Gotham Capital hedge fund manager racked up annualized returns of 40%, eclipsing the success of even his mentor, Warren Buffett.

Investors who were on board with Greenblatt for his entire tenure at Gotham would have seen a $10,000 investment balloon to more than $8 million, earning 800 times their initial stake.

His remarkable track record didn't happen by sheer luck, but rather through his focus on investing in a unique group of companies that shared one commonality.

Industry leaders like American Express, Liberty Media, Allstate, Expedia and Kraft Foods all carry this trait. And they each helped Greenblatt and fellow investors make millions...

These companies are just a few of a long list of spin-offs that all once belonged to larger parent companies. And they all flourished after leaving the nest.

Take spin-off biopharmaceutical maker AbbVie (NASDAQ: ABBV) for example. Since officially leaving its parent company, Abbott Laboratories, in January 2013, ABBV has risen more than 65%... beating the market by roughly 30%.

Here's another example. Just over two years ago, ConocoPhillips separated its upstream oil and gas production from its downstream refining operations to create two distinct companies. Shares of Phillips 66 (NYSE: PSX) were distributed to investors of ConocoPhillips and have since gone on to nearly triple in value, a healthy increase of 180%, compared to a return of just 45.4% for the S&P.

The success or these spin-offs aren't just isolated incidents. In fact, this phenomenon has been tested numerous times over the years with compelling results. One of the most famous studies was conducted by consulting firm McKinsey in 1999. McKinsey reviewed 168 restructurings over a 10-year period and found that shares of spin-offs produced annualized gains of 27% in the 24 months following separation, versus a 17% gain for the S&P 500.

That performance could have turned a $10,000 investment into more than $109,000 over 10 years against just $48,000 in a S&P 500 index fund. And that's taking the good with the bad -- without any effort made to identify the best-positioned spin-offs offering the most potential.

Skeptics might say that the results are skewed by a handful of big winners. But the facts say otherwise. A Lehman Brothers study between 2003 and 2006 found that two-thirds of all spin-offs went on to outperform the market. And since 2003, Bloomberg's Spin-Off Index has beaten the market 4-to-1. Check out the chart below.

Not bad for businesses that were essentially the "black sheep" of their parent companies. But there are several factors behind why spin-offs perform so well after separation.

You see, spin-offs happen for a number of reasons... Sometimes it's to cut loose certain operations to satisfy anti-trust requirements. Other times it's to resolve friction or conflicts of interest between a subsidiary and parent.

But the most successful spin-offs happen when a parent company wants to simply un-tether a fast-growing business that needs to be set free.

No matter how bright its prospects, smaller subsidiaries or business units tend to get lost in the shadow of the parent. Because their financial contribution is buried, they often don't get the full recognition they deserve. But once a growing arm of a company is spun off, the market can finally appreciate its true value.

Spin-offs also tend to be overachievers, if for no other reason than the new firm's leaders are suddenly free from bureaucracy and find themselves sitting on a bundle in stock options in the newly-formed company -- which provide a "rocket fuel"-like incentive for the company's growth.

So how can investors harness the power of spin-off companies?

One of the biggest opportunities I've found today is in a company that is walking the same path that ConocoPhillips took a couple years ago. It has a big spinoff planned for later this year. I talked about this stock in this month's issue of my premium newsletter advisory, Total Yield.

Like other "Total Yield" stocks, this one is a reliable dividend payer that gives away two "extra" payments in addition to dividends -- the secret ingredients for maximizing capital gains potential. (I talk about these "extra" payments in more detail in this presentation).

It's impressive enough that this Total Yield spin-off has raised its dividend for 12 straight years -- increasing shareholders' income streams by 476%. But even more impressive is how management has paid its shareholders $2.6 billion in "extra" payments over the past year -- 24% more than it paid in dividends. The company is already planning to pay shareholders $1.7 billion more in the future.

Besides this company, there are several funds created for the sole purpose of identifying the hidden opportunity in spin-offs. One of the oldest of these funds -- the First Investors Special Situations Fund (FISXX) -- has chalked up an annualized return of 9.2% over the past decade, outrunning the S&P 500 by more than 150 basis points per year.

Regardless of where you choose to find them, history is filled with examples of newly-listed stocks that shot higher in the weeks and months after being spun off from a parent company. And with a track record of beating the S&P 500 index by 4-to-1, these are companies worth looking into for your own portfolio.

P.S. -- Years of exhaustive research proves that a "Total Yield" strategy outperforms dividend-only strategies without question. Last year, 24 of the top 25 Total Yield stocks doubled the S&P's returns (and some by even more). These stocks gained 124%... 132%... even 224% -- in less than 8 months. To learn more about Total Yield investing and get names and ticker symbols of these stocks like the one I mentioned earlier, follow this link.

Nathan Slaughter does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.