One key to success on Wall Street is finding the few opportunities when Wall Street does not efficiently price stocks. Corporate spin-offs are such opportunities.

A spin-off occurs when a company "spins off" ownership in a division or business to its existing shareholders. The division becomes an independent, publicly traded entity.

For example, two spin-offs that many investors own are Lucent Technologies and NCR. These companies were spun off by AT&T.

A firm may spin off a business because it no longer fits its long-term corporate strategy. A firm that believes it is undervalued may spin off a business with the hope that the spin-off plus the old company will be worth more as parts than as a single company.

If you are the registered shareholder of a company spinning off a division, in most cases you will receive stock certificates representing whole shares in the spin-off company and cash for any fractional-share ownership.

If your shares are held by a broker, the shares will be credited to your brokerage account.
Spin-offs are usually classified as tax-free distributions. You will not incur a tax liability on spin-offs until you sell your shares. However, following a spin-off, you have to readjust your cost basis on the shares of the former parent company. Also, you'll have to determine a cost basis for the new shares. Companies often disseminate a document showing the proper cost adjustments to make.

Factors unique to spin-offs often cause investors to sell the shares regardless of their underlying value. For example, following a spin-off, it is not uncommon for the new company to offer an "odd-lot buyback program." Under an odd-lot program, the new company approaches investors holding "odd lots" (less than 100 shares) and offers to buy back the shares. Companies conduct odd-lot programs to help reduce the number of shareholders, thus reducing shareholder-servicing costs. Since many investors own less than 100 shares in a spin-off, the odd-lot program presents a way for these investors to bail out of the stock and pay little or no brokerage commissions.

Another factor that depresses the stock is that many spin-offs pay little or no dividends initially. An investor who likes to receive dividends may have limited interest in a stock that doesn't pay a dividend.

Finally, it's likely that the investor bought the former parent company because it liked its primary business. The investor may have little interest in and knowledge about the spin-off's business.

The upshot is that investors who receive the spin-off shares probably have more reasons to sell the shares Ñ pressure from the company to participate in the odd-lot buyback program, little or no dividend, little understanding of the spin-off's business Ñ than to add to their holdings. When investors dump a stock for reasons unrelated to the company's earning power and appreciation potential, buying opportunities are created. To be sure, not all spin-offs are worth holding. Some spin-offs have a lot of debt and other long-term obligations dumped on them by the former parent company and may be unattractive. Still, investors should avoid dumping spin-off shares merely for convenience sake, as history has shown that you may be dumping investments with solid potential.