This 'Boring' Trick Has Outperformed the S&P 500 By 45%

It goes without saying that the stock market is an extremely competitive arena. Money management firms spend millions to find profitable niches, strategies and tactics.

Where short-term trading is concerned, the advent of high-frequency trading has made speed more important than ever. This niche has become so competitive that some firms have relocated their operations to their stock exchange’s facilities to get their orders to the exchange before the competition’s.

Fortunately, long-term investors don’t have to concern themselves with the arms race in high-frequency trading. While large firms fight it out for microsecond advantages, long-term investors can exploit time-tested niches. One such niche outperformed the S&P 500 Index by an average of 13% from January 1995 to July 2012, including a period of 45% outperformance between 2000 and 2005.

However, the success of this strategy hasn’t captured investors’ interest. One reason, to be frank, is that it’s a little boring in comparison to other investing strategies. Another is that after the catalyst for this strategy occurs, shares often trade lower for the first month or so. A third is that this strategy was decimated during the 2008 financial crisis. These factors appear to work in unison to spook many investors despite the high returns.

This strategy is known as spin-off investing. It entails buying shares in a company that has been spun off from a larger parent firm. A parent company may have many reasons for spinning off a subsidiary, but typically, the primary goal is to increase shareholder value by jettisoning debt and slashing expenses.

Yet shareholders of the original company often dump their granted shares of the new, smaller company. They often have no interest in owning the spun-off company, so they sell their shares, sending the spin-off’s stock lower — at least initially. However, other investors often recognize the value in the spin-off’s lower price, sending shares on an upswing.

Spin-offs are often successful, and one main reason is that the spin-off’s executives are frequently given greater incentives — in the form of stock options in the new company — to succeed than they may have had at the parent firm. Think of a spin-off as a startup — but one with a seasoned executive staff, an existing business model and customer base, and direct experience in the field.

You can search for pending spin-off companies on the Securities and Exchange Commission website and by keeping up with the financial news. Several of the most successful spin-offs include Hillshire Brands (NYSE: HSH), spun off from the Sara Lee Corp.; Mondelez International (Nasdaq: MDLZ), spun off from Kraft (Nasdaq: KRFT); and Phillips 66 (NYSE: PSX), spun off from ConocoPhillips (NYSE: COP).

My favorite way to invest in spin-offs is to gain diversified exposure to the best spin-off companies through the Claymore Beacon Spin-Off ETF (NYSE: CSD).

The top 10 holdings include:

With $370 million in assets under management, this exchange-traded fund comprises the 25 spin-off stocks ranked highest by the fund manager‘s proprietary methodology. Each stock can represent at most 5% of the portfolio, ensuring solid diversification and making the ETF less risky than individual stocks. CSD is up nearly 39% this year and boasts an average five-year return of nearly 20%.

Risks to Consider: This ETF got trounced during the 2008 financial crisis, and it’s tightly tied to the overall economy. Always use stop-loss orders and diversify across sectors and strategies in your ETF portfolio.

Action to Take –> Buying on a breakout close above $44 with a 12-month target price of $50 makes solid sense.

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- David Goodboy

This article originally ran on StreetAuthority.com as: Forget High-Speed Trading: Beat The Market With This Boring Strategy.

This article originally appeared on InvestingAnswers
Author: David Goodboy
StreetAuthority
This ‘Boring’ Trick Has Outperformed the S&P 500 By 45%