The Hottest Trend in Investing Today

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Most investors want to see big growth from the companies whose stocks they own. But increasingly, it seems like the favorite news shareholders can hear is that their company is breaking itself up into pieces.

Look back over the past year and you'll find plenty of companies that are splitting themselves into pieces. Motorola stuck its mobile business into Motorola Mobility (NYS: MMI) early in 2011 -- just in time for Google to snatch it up in a $12.5 billion deal. Marathon Oil's decision to spin off its underappreciated refining business into a separate subsidiary was so popular and lucrative that ConocoPhillips (NYS: COP) now plans to follow suit. With conglomerate Fortune Brands selling off its golf business and planning to spin off its home security unit and Pfizer (NYS: PFE) considering a spinoff of its own, breaking up has never been easier to do.

When the whole is less than the sum of its parts
If that sounds like fuzzy math, there's a good reason: It's the exact opposite logic that you hear when mergers and acquisitions are in vogue. Companies that are tying the knot usually argue that because of potential cost savings and the value of combining complementary divisions within a single corporate entity, the prospects for their joint businesses going forward are stronger if they unify their efforts.

But at times like this when spinoffs become more popular, it's easy to find statistics talking about how rarely mergers and other business combinations end up adding value. What seem like promising pickups for growing companies often turn out to be serious missteps that end up not only falling short of their potential but also threatening their very survival. In that light, the divide-and-conquer strategy seems like a less foolhardy way to focus on certain investing areas.

More often, though, the incentive for spinoffs comes from some market inefficiency that undervalues a certain type of business. For instance, right now, investors have painted just about every financial stock with the same tarring and feathering that they used to reserve for the most endangered institutions. Some now see the ultimate financial conglomerate, Berkshire Hathaway (NYS: BRK.B) , as severely underpriced relative to its intrinsic value. That's inevitably due not only to its core insurance business but also its huge position in shares of bank stocks.

Far from a sure thing
What investors remember most about spinoffs are the success stories. Whenever the idea of spinoffs comes up, success stories inevitably follow. With Chipotle (NYS: CMG) and its 46% annual share-price gains over the past five years doubling former parent McDonald's (NYS: MCD) and its still-impressive 23% rise, avarice grabs hold of executives as they consider spinoffs of their own.

But not every spinoff succeeds. According to research from consulting firm A.T. Kearney, parent companies often make mistakes when they decide that units need to exist on their own. The current controversy over Netflix (NAS: NFLX) and its recent decision to separate its legacy DVD-rental business into the newly named Qwixster subsidiary has raised many of the concerns that commonly come up with parent-spinoff situations, including how to divide shared resources and costs between the two new entities, interactions between the two newly independent entities, and public perception of the split. If parent companies don't walk the fine line between providing enough transitional support and allowing a spun-off company to succeed or fail on its own, then the results can be disastrous.

Not a silver bullet
As popular as spinoffs have been lately, you shouldn't see them as an automatic victory for shareholders. In this environment, most companies announcing spinoffs can expect short-term share gains. But truly assessing whether dividing up a company will add value takes a lot more effort -- and sometimes, you'll find that the spinoff that other investors are praising gives you a chance to head for the exits before the bottom falls out of the deal.

Spinoffs aren't the only way to find great stocks. Read this free special report from The Motley Fool to learn about five stocks we own that you should, too.

At the time this article was published Fool contributor Dan Caplinger has never been trendy, but he likes investments that never go out of style. You can follow him on Twitter here. He owns shares of Berkshire Hathaway. The Motley Fool owns shares of Google, Chipotle, Berkshire Hathaway, and Fortune Brands. Motley Fool newsletter services have recommended buying shares of Pfizer, Google, Fortune Brands, Netflix, Berkshire Hathaway, Chipotle, and McDonald's, as well as creating an iron condor position in Chipotle and a bear put spread position in Netflix. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy is hot, hot, hot!

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