The grocery store makes it easy because it’s all right there.  From toilet paper to apples if you want to take the time you can calculate, prod, read, and decide which product has the best value for you.  And anyway, if that new brand that seemed to be such a deal isn’t, you’ll be going back to restock soon anyway.

Now turning to stocks, we want to buy low and sell high.  We want  to find stocks that are likely to go higher than they are now so that we can sell them and make money.   One way to do that is to find a stock that is a bargain, one that has good value.

The thing is, it can be very difficult to tell the difference between true value,  a stock whose price is low by the usual backward looking measures, but is actually priced just right going forward,( in other words one that is down there for good reason), and one that is irrationally, mistakenly, or unfairly undervalued.

Of course it is the latter that we value investors are looking for and spin-off stocks are a great place for find real value;  stocks whose price is depressed for reasons unrelated to the company’s prospects.  In Joel Greenblatt’s language, this is a pond into which we want  to throw our bait in hopes of hooking a big one.

With a spin-off date of October 6, 2008, what I first found was a stock in a downtrend that kept downtrending after the spin-off.  This is what smart money does with insider trading?  Well, actually, no they didn’t.

First, they were investing in the parent company, AMD.  They bought well before the rest of us knew whether the spin-off would get funded or not and actually saw about a 25% increase in share price at one point.  Then the market and the stock rolled over and started down.  By the time the actual spinoff occurred it was no secret which way things were heading.

The prosecutors were credited with saying that though they didn’t make money on the trade because the whole market headed south, they were definitely trading on illegally obtained information.   I could not tell whether they were saying that the alleged insider information traders would have made money had the market played along or that it didn’t matter whether they made money or not.

The question about all this that I have is whether it is giving us any new information about what our trading plan for stock spin-offs should be or not.  At this point my conclusion is that I will stick with seeking out spin-offs that are likely to lead to an initial drop in the price of the spun-off stock that creates a value situation and then entering when it turns up.  This one never really fit that bill, no matter what an interesting story it has provided. 

(Are those people crazy?  Seems like they were making more than enough money honestly than to feel they had to risk jail for some more.)

One of the commonly mentioned reasons that spin-off stocks create value situations is that the method for distributing the stock is inherently inefficient.  It is given to everyone who owned the parent company on a certain date and it is not uncommon for many of those shareholders to not want to own a piece of the new company irrespective of its inherent value or future prospects.

A spin-off’s stock may not be attractive to the recipients for a number of reasons including that

• they did not choose to invest in this company and likely view it as a hassle to get up to speed on whether they want to hold it or not
• the number of shares distributed is often small relative to the original holding in the parent company, again leading to a “sell it to keep things simple” kind of decision
• the size of the new entity is likely to be small and/or in a different sector from that of the parent, forcing institutions to sell it if it does not fit their criteria for inclusion
• if it is not to be included in a particular index, then funds that consist of or invest soley in components of that index have to sell

In the case of CareFusion several of these reasons for the stock price to decline shortly after it starts trading appear to be missing.  CareFusion is

• in the medical field as is the parent, Cardinal Health
• to be included in the S&P 500
• a big, followed company with generally agreed upon solid prospects.

Other “reasons” for spin-off success are still there:  focus, executive motivation, investor favor for a “pure play”.  So which way will it go?  Another stock spinoff success story, or something else?

Fortunately we have our two old reliable friends, price and volume, to tell us exactly how it is going.