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Stock Strategist

Finding Value in Spin-Offs

Price can be deceiving for these often-overlooked stocks.

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One common lament I've heard recently from more than a few knowledgeable investors is over the relatively "flat" valuation of the market. Unlike 2000, when the market's overall rich valuation masked an enormous divergence between overpriced sectors like tech and telecom, and underpriced areas like REITs and small caps, there don't seem to be too many large pockets of opportunity in the market right now. Sure, there are interesting ideas scattered around--after all, we have about 50 5-star stocks right now--but not too much that's screamingly cheap, in my opinion.

The relative dearth of slam-dunk ideas led me to recently revisit a long-standing interest of mine--corporate spin-offs, which I regard as one of the few market inefficiencies still out there. In my experience, spin-offs are frequently undervalued and offer fertile ground for investors looking to buy dollars for $0.70 or $0.80. Although I've seen systematic studies that argue this topic both ways--some say spin-offs outperform the market in aggregate, and some present a more mixed picture--I'm not too interested in the aggregate data. After all, it would be silly to buy every spin-off blindly. The point is that they're frequently misvalued (more on why in a moment), and a little research to ensure that you're not buying a pig in a poke can go a long way.

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Pat Dorsey does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.