What are cannibal stocks? Well as the word implies it is companies that literally eat themselves!
Shares in companies that buy back their own shares on the market on a huge scale are cannibal stocks. Shareholders can benefit from this phenomenon as their relative stake in the company increases without them having to invest further.
Cannibal shares are issued by companies that make a substantial buyback of their own shares. Let’s take an example where you own shares in a company with earnings of £10 per share. Earnings per share (EPS) will rise from £10 to £20 if the company buys back 50% of its outstanding shares. The share price should also double theoretically, reflecting this increase in EPS.
Mohnish Pabrai provides an overview of the magic of buybacks:
It’s imperative to stress that share buybacks only create value when stocks are undervalued. Indeed, the process of buying back shares can be viewed as an investment in the company itself. Likewise, as an investor, you look to acquire shares when they are undervalued.
Share buy-backs are often taken as an indication that management believes in the intrinsic value and financial strength of their company and are therefore a sign of management confidence. It is essential however for investors to carry out their own analysis to determine whether such shares are actually undervalued before considering buybacks as a positive signal.
Cannibal stocks can represent an attractive opportunity for shareholders to see their holdings in the company increase through share buybacks. However, if these buybacks are to result in real value creation, the assessment of the undervaluation of the shares remains a decisive factor.
Builders FirstSource (BLDR): This Texas-based supplier for home construction has significantly expanded its market presence by acquiring over 60 smaller firms over the past 25 years. Additionally, Builders FirstSource has repurchased approximately 45% of its own shares, showcasing an aggressive buyback strategy. The board recently authorised a new $1 billion buyback program, underscoring the company’s commitment to returning value to shareholders.
Apple Inc. (AAPL): Apple has consistently engaged in substantial share repurchase programmes, returning significant capital to shareholders. This strategy has contributed to its strong stock performance over the years.
Microsoft Corporation (MSFT): Microsoft has implemented ongoing share buybacks which have played a role in enhancing its EPS and supporting its stock price appreciation.
Alphabet Inc. (GOOGL): Alphabet has authorised significant share repurchase programs, aiming to reduce the number of outstanding shares and increase shareholder value.
Berkshire Hathaway (BRK.A, BRK.B): Under the leadership of Warren Buffett, Berkshire Hathaway has engaged in share buybacks, particularly when the company’s stock is perceived to be undervalued.
Investors should consider that while share buybacks can indicate a company’s confidence in its financial health and prospects, they are just one factor to evaluate. It’s essential to assess the overall financial performance, market conditions and individual investment goals when considering investments in companies employing aggressive share repurchase strategies. You know it makes sense.*
Tony Byrne, Managing Director
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*Risk warnings
The value of investments can fall as well as rise. You may not get back what you invest. The information contained within this article is for guidance only and does not constitute advice which should be sought before taking any action or inaction. All information is based on our current understanding of taxation, legislation, regulations and case law in the current tax year. Any levels and bases of relief from taxation are subject to change. Tax treatment is based on individual circumstances and may be subject to change in the future. This blog is based on my own observations and opinions.
