Goldman’s Kostin: Why we're focused on spinoffs

spin workout

Corporate spinoffs look like an attractive investment opportunity in an expensive market, Goldman Sachs Chief U.S. Equity Strategist David Kostin said Tuesday.

The value of spinoffs and carve-outs at completion surged 81 percent to $176 billion last year, according to Goldman Sachs research. 

"The idea of looking at spinouts as an investment strategy is an important one," he told CNBC's "Squawk on the Street." "We expect that there will be high levels of spinouts this year because margins are high and the economy is growing at a modest level."

That has left companies looking for new ways to return value to shareholders.

The firm identified three characteristics that make for a successful transaction. New companies that are in a separate industry and have lower price-to-earnings ratios and lower expected returns relative to the parent typically fare well, Kostin said.

Companies with those characteristics outperform their parent 90 percent of the time, typically putting up 50 percentage points in excess return above the parent's in the first two years, he said.

Goldman is also focused on domestic-oriented companies on the view that the dollar will strengthen against a backdrop of U.S. economic growth and higher interest rates, Kostin said.

"Companies with domestic revenues will continue to outperform. That is in fact the most important narrative that has taken place over the last five years," he said.

Investors could soon have a tougher time finding returns in the stock market as a key driver, corporate share buybacks, winds down in the coming weeks, Kostin added. Money flow was a bigger factor than growth or value in February, as companies authorized a record number of share repurchases this year, he said.

"That's a tailwind sentiment indicator that suggests that positioning in the market is still very light with respect to the futures market," he said.

"But then the window will close and then you'll be in a situation where it will be about, really, valuations and growth. And the market is at pretty expensive levels."

Kostin expects the S&P 500 to rise roughly 5 percent this year from the current level just below 2,000, essentially ending 2016 flat.


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