This is a follow-up of sorts to the top dividend-paying spinoffs that I outlined last month.
I continue to believe that spinoffs are great ways to beat the market. Just look at the Guggenheim Spin-Off ETF (NYSEARCA: CSD) ETF, which is up 82% since 2007, compared to the S&P 500’s 42% return.
Joel Greenblatt, the famous hedge fund manager, author of “The Little Book That Beats the Market,”agrees. “Both spinoffs and merger securities are generally unwanted by those investors who receive them […] as a result, both spinoffs and merger securities can make you a lot of money,” Greenblatt has said.
Meanwhile, “Margin of Safety”author and hedge fund manager Seth Klarman has observed that with spinoffs, “there’s a natural constituency of sellers and not a natural constituency of buyers.”
What this means is that a spinoff’s stock price is kept artificially low. New owners of the spinoff continue to sell shares of the company because they are not interested in owning the spinoff. But there are not many buyers in the beginning, given the fact that the market is inefficient at digesting the business models of newly spun-off companies.
A big positive for spinoffs is that expectations, management incentives, strategies and even cash-flow allocation are all reset. It’s almost like being able to invest in a new company with a renewed focus on its key market.
With that, here are the top five spinoffs worth owning today:
Spinoff No. 1: CDK Global (NASDAQ: CDK)
CDK spun off from Automatic Data Processing (NASDAQ: ADP) in September. CDK provides advertising services to the auto industry, which includes marketing campaigns for car sales, car repairs and even vehicle insurance and financing.
CDK is up 18% since its spinoff and has no debt and over $380 million in cash, which covers 7% of its market cap. CDK also already has an activist investor involved with the stock. Sachem Head Capital, an activist hedge fund, bought up nearly 10% of the company last month and is looking to meet with management. The big positive for CDK is that it has exposure to the rebounding auto industry.
Spinoff No. 2: Seventy Seven Energy (NYSE: SSE)
Seventy Seven Energy is the spinoff from Chesapeake Energy Corp. (NYSE: CHK) from June. Much like all stocks tied to oil, Seventy Seven Energy is down big over the last few months — shares have fallen 50% since the spinoff.
Seventy Seven Energy is an oilfield services company that provides services such as drilling to land-based oil and gas exploration companies in the U.S. The one issue is that it has $1.6 billion in debt, compared to its $672 million market cap. However, the valuation is still very appealing.
It trades at a forward P/E (price-to-earnings ratio based on next year’s earnings estimates) of just 7. Seventy Seven Energy still has heavy ties to Chesapeake Energy, which is one of its largest customers, and with Chesapeake’s recent steps to strengthen its balance sheet, that’s a big positive for Seventy Seven Energy.
Spinoff No. 3: Time Inc. (NYSE: TIME)
In June, the entertainment company Time Warner Inc. (NYSE: TWX) spun off its magazine publishing unit as Time Inc. Since then, shares of Time Inc. are up just 2%.
Time Inc. publishes over 20 magazines in the U.S., including People, Time and Sports Illustrated. It also publishes 70 magazines outside the U.S. It generates over half of its sales from selling advertising space, while the majority of the rest comes from subscription sales.
It trades at a forward P/E of 15 and generates strong cash flows. The company is pulling in about $450 million in annual free cash flow. It plans to use about 30% of free cash flow to pay a dividend going forward. That works out to about $1.30 in annual dividend payments and would be a dividend yield of over 6%.
Spinoff No. 4: Lands’End (NASDAQ: LE)
Lands’End spun off from Sears Holdings Corp. (NASDAQ: SHLD) back in April. It’s been the best performer of the spinoffs we have listed here — up over 35% since its spinoff.
Unlike its former parent, Lands’End is not a struggling brick-and-mortar retailer. It primarily operates as an online and catalog retailer of clothing, accessories and home products. Over 80% of its revenues are generated online. Lands’ End also has operations in Japan and Europe and it has plans to tap the fast-growing China market.
What’s more is that shares are still enticing, trading at a P/E ratio of 17 and with a very solid 20% return on equity. Coupling its P/E ratio with expected earnings growth and Lands’End’s PEG (P/E-to-growth rate) is a mere 0.9.
Spinoff No. 5: Blackhawk Network Holdings (NASDAQ: HAWKB)
Blackhawk is the April spinoff from the grocery retailer Safeway Inc. (NYSE: SWY). It is a prepaid payment network that offers gift cards and prepaid credit cards. Although its P/E ratio of 35 looks fairly high, it has a high return on equity of 25% and a positive net cash (cash less debt) position.
It’s also the industry leader, with nearly 70% of the Fortune 100 companies using Blackhawk’s services. It does a very good job of keeping its customers, with a retention rate of over 90%. As far as growth goes, it plans to tap the international markets and prepaid telecoms.
A number of studies have shown that spinoffs tend to outperform the market in the first couple years of trading. The five stocks above are still in in the first year of their spinoffs and look enticing from an investment standpoint.
This article is brought to you courtesy of Marshall Hargrave from Wyatt Research.