The aroma of frying brain wafted into the imaginations of moviegoers in 2001's Hannibal. In one scene, Anthony Hopkins's fiendish Dr. Lecter feeds Ray Liotta's stupefied Paul Krendler a chunk of his own grey matter. Call it fine dining at its most horrific.
Cannibals can be found beyond the silver screen and a few lurk in the stock market, where self-cannibalism goes down well with investors. These aren't a bunch of modern-day Sweeney Todds who grind up redundant employees and stuff them into pies. Stock cannibals simply eat their own shares.
There are two basic ways for companies to send money to shareholders. They can pay dividends or buy back their own stock. Many do a combination of the two.
Just keep an eye out for firms that use share-repurchase programs to cover ravenously greedy managers who get gut-bustingly large option grants. In such cases, the repurchases should be viewed as payoffs to insiders.
But companies that actually enrich their shareholders tend to perform quite well over the long run.
Money manager James O'Shaughnessy studied the impact of stock self-cannibalism in his book What Works on Wall Street. He specifically considered a firm's buyback yield, which he defined as the year-over-year percentage change in a firm's shares outstanding. He calculated the figure so that firms with declining share counts had positive buyback yields.
A portfolio containing the 10th of large U.S. stocks with the highest buyback yields, rebalanced annually, gained an average of 13 per cent a year from 1927 through 2009. Alternately, a portfolio composed of the 10th of stocks with the lowest buyback yields (largest share count growth) gained 6.1 per cent annually over the same period. By way of comparison, the market climbed at an annual rate of 9.7 per cent during the period.
Investors get a big return boost from self-cannibals. Problem is, there are relatively few firms that make a habit of significantly reducing their shares. Most firms swell the number of shares they have through management options and ill-advised acquisitions. As a result, it's a good idea to look at how a firm's share count has varied over the years before investing.
There are three companies on the TSX with market capitalizations in excess of $250-million that have reduced their share count by more than 10 per cent over the past year, according to S&P Capital IQ. They are BMTC Group Inc. (GBT), Canadian Pacific Railway Ltd. (CP), and Celestica Inc. (CLS). Both BMTC and Celestica have been reducing their shares outstanding for years, whereas Canadian Pacific Railway is a relatively new cannibal.
BMTC Group makes its home in Montreal and represents an interesting case. The firm operates a modest collection of retail stores in Quebec that sell furniture, household appliances and electronics.
Over all, it is a relatively small enterprise with a market capitalization near $485-million. It generated sales of $710-million over the past 12 months and earnings of $43-million.
Unfortunately, BMTC Group's business has been ailing in recent years because its revenue peaked at $856-million in 2008, when it earned $70-million.
More positively, the firm cut its share count by a whopping 16 per cent over the past four quarters. It also has a long record of reducing its shares outstanding with declines seen every year since well before the turn of the century. Over the past decade the company sliced its share count nearly in half. Add in a dividend yield of 1.8 per cent and it's clear the company likes to return money to shareholders.
On the valuation front, the stock trades at 13.5 times earnings. Its balance sheet is buttressed with $52-million in long-term investments and basically no long-term debt.
With the stock trading at about half its 2010 highs, investors might think about nibbling on this tasty self-cannibal while sipping a nice Chianti.
Norman Rothery is the value investor for Strategy Lab. Globe Unlimited subscribers can read more in the series at tgam.ca/strategy-lab.