I have something pretty special for your today, and it comes from our favorite value investor Mohnish Pabrai. Remember the Shameless Portfolio? Where Pabrai gave us a way to shamelessly copy some of the best investors in the world? And for our trouble, we could see a return that beats the S&P 500 by 10.7% on average. Well he’s done something similar, and he’s giving it to us for free, Again! So pay attention all you Mutual Fund, Index, and ETF investors. This may be the ‘fund’ for you (and anyone else of course).
As you’ll recall, last time we learned everything we needed to know about share repurchases. We learned:
1. What a share repurchase is
2. What it means for us as investors
3. Top reasons for a repurchase
4. The only time a company should buy back its shares
5. How share buybacks can benefit your dividend
6. Buffett’s take on share buybacks
All that was very interesting, and important to know, but today I found something that can let us see how powerful a share repurchase program can be first hand. Not only that, we’ll look at the companies that Mohnish Pabrai calls the ‘Uber-Cannibals’. Don’t worry, they aren’t eating other companies (Even though they taste delicious…) Instead, they devour their own shares at a fairly alarming rate. Of course, if you remember the benefits of a share repurchase, you’ll know that this can be extremely beneficial to us as shareholders. These companies act like Pacman, running around eating as many chunks of shares as possible. All the while increasing our ownership in the company, their earnings, and consequently, our return.
Here’s what we’ll discover today:
1. What exactly is an Uber Cannibal?
2. The Uber Cannibal Portfolio
3. The best thing about an ‘Uber Cannibal’
4. How well the Portfolio has performed over the last 24 years
5. The Rules
6. The Current Cannibals for 2017-2018
7. How to use the Portfolio
Once again, Mohnish Pabrai (my Value Investing man-crush) delivers to us another market crushing Portfolio. I think you’ll be excited to see how well the Portfolio performs. This time around he worked with a quant analyst named Yingzhuo Zhao, to find the top Five cannibals in the market today. What’s a Cannibal you ask? Well you’re about to find out.
Pabrai, being awesome, will also release an updated list of the Five potentially great Cannibal companies for us every year (around the end of March). I’ll keep you updated on that list as well, so check back here in the future.
What do you mean ‘Uber Cannibal’?
Mohnish Pabrai originally co-wrote the article that ran in Forbes on December 22, 2016. Pabrai defines an Uber-Cannibal as a business that is:
1. Cash rich
2. Undervalued, and is
3. Consistently buying back shares
He believes that these three factors can lead to tremendous value generation for the shareholders. Remember the buyback rules from last time? A management team should only Buyback their own stock when it is a good price to underlying Value. It seems like Pabrai would tend to agree. After all, the CEO should be an expert in the business, and therefore, should understand the underlying value of that business. The problem is, a lot of the time, we don’t get value investors at the helm of large companies. And because of this, these CEO’s will Buyback stock at any price simply because it has a positive impact to their earnings numbers. It also has a generally positive appeal to investors. But we know better. So we’re more careful about who we invest our hard earned money in…
In the article, they introduce the idea behind ‘Uber Cannibals’, and compare it to the Small Dogs of the Dow. Mohnish Pabrai is a huge fan of Charlie Munger, who is also a big fan of share Buybacks. In fact, if you look at their top 3 holdings over the long-term (Coca-Cola, American Express, and IBM) you’ll find that they are huge cannibals, with IBM gobbling up more than 60% of its shares in the last 28 years.
- Coca-cola devoured 26.8% &
- American Express ate 24.7%
For perspective, $100,000 invested in these three companies when Berkshire bought them would have returned a sizeable 4,200% in that 28 period. In other words, that $100,000 would have turned into an incredible $4.2 million. And that’s even more impressive considering IBM’s terrible performance of only 1.3% annualized since Berkshire bought it back in 2011. In other words, Focusing on the Cannibals could turn into large returns for us as investors.
The best thing about a Cannibal
To me, the best part about a company buying back shares instead of paying a larger dividend is that they avoid something called double taxation. In other words, the company is taxed on their earnings, and then you are taxed on the dividend they payout to you. With Buybacks, the taxes can be deferred to a later date, avoiding the upfront double taxation of a dividend.
Another way to avoid double taxation would be to have your large dividend earnings in a tax free account. That way, any gains or dividends you earn would never be taxed on your end, which can be really important for protecting our gains.
Pabrai’s Cannibalistic Portfolio
Mohnish Pabrai and Yingzhuo Zhao, decided to pool their resources and asked the question “How would a portfolio of the top five biggest cannibals perform over time?” They took this idea from the Small Dogs of the Dow, which is a strategy based on the 5 cheapest, highest dividend yielding stocks of the 30 in the Dow Jones Industrial Average. The stocks are equally allocated and reset at the beginning of each year.
For Pabrai’s Portfolio, Yingzhuo wrote some code to find the largest ‘Uber Cannibals’ going all the way back to 1992. They then tracked that portfolio’s performance and were likely impressed with the results.
Uber Cannibal results
Over the 24 year period of backtesting, the Uber Cannibals didn’t just beat the market (S&P 500) they destroyed it. Here’s the chart from Pabrai’s post:
(Mohnish Pabrai, 2016)
As you can see, the Uber Cannibal Portfolio crushed the S&P 500 by 6.3% on average per year since 1992. Said another way, your $100,000 would have turned into a whopping $3.6 Million if you followed this algorithm, while investing in the S&P would have returned a respectable $904,314.
Uber Cannibal Portfolio Rules
Selection Criteria:
1. Minimum market cap of $100 million.
2. Price/Sales Ratio of less than 2.5.
3. The share buyback percentage over the dividend yield for the last 1 year is required to be greater than 2.
4. No insurance companies.
5. Must have a minimum of a 5% increase in trailing twelve month revenue over the previous year and 20% over the last five years.
6. The company must have reduced its share count by 3% in the previous year.
Subject to the above restrictions, they elect the top 5 cannibals by share count reduction over the past 5 years.
Rebalance Methodology
1. Rebalance on March 18th of each year. Public companies are required to report year-end numbers by March 15th. So, we are using audited year-end numbers.
2. The old companies that are not in the new portfolio are sold. The “sell money” is accumulated and distributed equally among all new entrants.
3. If the same company is present in our portfolio for another year, then we leave it unchanged i.e. no rebalancing trades.
- Dividends are reinvested into the same company that paid it.
- If there is an involuntary removal through acquisition/delisting/bankruptcy then the cash is distributed equally among the remaining cannibals.
- If there are any spin-offs, the shares are sold and reinvested in the parent.
Uber Cannibals for 2017-2018
| Company | Ticker Symbol |
1 | Lowe's | LOW |
2 | NVR | NVR |
3 | The Hackett Group | HCKT |
4 | Select Comfort | SCSS |
5 | Willis Lease Finance | WLFC |
How to use the Uber Cannibal Portfolio
Disclaimer:
Anyone who decides to invests in any strategy (including this one) needs to do their own research/due diligence and are themselves fully responsible for the outcome.
Alright, now that we have the list for the current cannibals, it’s important that you don’t just go out and buy them without knowing some ground rules.
First: Pabrai set this up as a yearly and equally weighted portfolio. That means that you allocate the same amount of capital to each pick each year (Not the same number of shares).
Second: For this portfolio to work, you have to follow the rules. More importantly, you need to follow them for long periods of time. Ideally for more than 20 years. Even though this portfolio will likely outperform the market during times of market stress, that could still mean a loss. You must hold and rebalance the portfolio over a long period of time to make up for the periodic losses. So, if you want to do this, commit long term.
Don’t think of it as just trying out the portfolio for a year to see how it does, if you do it, Put a ring on the thing and commit to it for the long haul.
Third: Pabrai has stated that he will give an updated list out each year for as long as he can. If you’re on my Email list, I’ll send you the new company list as soon as they are posted. So, keep an eye out. (or both eyes, your choice).
Fourth: Between rebalancing, set it and forget it. This should be an extremely low stress investment, and it’s important to treat it that way.
Fifth: If you get the chance, say thank you to Mohnish Pabrai. He does all of this for us. It would be nice to give the appreciation he deserves.
(say thanks on his Website, or on his twitter @MohnishPabrai).
Resources
If you wanted to do your own research, and find some companies to invest in individually that Buyback shares, I’d first start with the list above, then move onto this one stop shop resource:
I also highly recommend that you regularly check Pabrai’s website:
Summary
Another potentially great portfolio, from one of the world's greatest investors. This could be another great addition to anyone’s portfolio. Better yet, if you combine it with the Shameless Portfolio, you’ll be constantly investing side by side with 5 of the best investors in the world, while simultaneously investing in 5 of the best Cannibals in the market. That sounds pretty sweet to me.
Next time I want to run through a quick Valuation on Lowe’s, and see if I would be a buyer if it was outside the Uber Cannibal Portfolio.
That’s it for today,
we’ll talk again soon.
~Ryan Chudyk~
PS:
to stay up to date on the Uber Cannibals and to learn more about investing, sign-up to my Newsletter. As a thank you for reading, I’ll send you my NLI Checklist. Sign-up today! (No spam ever, just emails from me to you)
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