5 Stocks Worth Watching

This article is part of our Rising Star Portfolios series.

The field of special situations can be a happy hunting ground. As Joel Greenblatt details in his You Can Be a Stock Market Genius, special-situation investing led him to 50% annualized returns for a decade. That type of return transforms a $1 investment into $52 in just 10 years.

Such special situations are created by transactions that transform the business -- spinoffs, reorganizations, and recapitalizations, to name a few. But the value created by such transactions often isn't reflected in financial statements, so agile investors can get a jump, and a good price, on these stocks before they appreciate to full value. Also, these situations can be complicated, but it's this transactional complexity that creates opportunity.

Five spinoffs
Below are five recent or pending spinoffs that could be attractive investment candidates:

McDermott's recent spinoff of Babcock & Wilcox frees the spinee to concentrate on its core customer: the U.S. government. B&W has two main segments: power generation systems and government operations. The spinoff should allow the new company to compete more effectively, since there was speculation that McDermott would suffer under recently amended federal acquisitions regulations.

Shareholders of Sun Healthcare are set to vote later this week on the proposed spinoff of Sabra, a real estate investment trust that would own Sun Healthcare's buildings.

Motorola looks to spin off its unit that covers mobile devices and the home early next year. The proposed spinoff company posted a $1.3 billion loss on $11.1 billion in sales in 2009.

Commercial real estate company General Growth Properties has attracted a lot of investor interest, with Pershing Square's Bill Ackman and Fairholme's Bruce Berkowitz helping the giant emerge from bankruptcy. With the help of these sharps, GGP has decided to spin off a collection of properties called Howard Hughes. The spinoff's assets look unattractive on the surface, but Ackman asserts: "It's a phenomenal collection of irreplaceable assets and they have a lot of long-term value."

Northrop, the U.S. Navy's largest shipbuilder, recently suggested it might want out of the shipbuilding game. The company has filed the regulatory paperwork to begin the process. The spinoff of the low-margin shipbuilding unit could make the parent more attractive.

These are a few of the special situations I'll be investigating as part of my real-money portfolio.

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