Idea Brunch with Deiya Pernas of Pernas Research
Welcome to Sunday’s Idea Brunch, your interview series with great off-the-beaten-path investors. We are very excited to interview Deiya Pernas!
Deiya is the co-founder of Pernas Research, a value-focused research firm that produces in-depth stock research. Before launching Pernas Research, Deiya was the Deputy Chief Investment Officer of The Bahnsen Group and an analyst at Morgan Stanley. Deiya is also active at @pernasresearch on Twitter.
Deiya, thanks for doing Sunday’s Idea Brunch! Can you please tell readers a little more about your background and why you decided to launch Pernas Research?
I've spent thousands of hours playing and studying poker, both during my college years and my time in the Air Force. Playing poker successfully requires a keen awareness of the irrational factors that drive decision-making. Much like financial markets, poker is a game of incomplete information, and you quickly learn the challenges of drawing correct lessons from both winning and losing periods.
My passion for poker naturally led me to the world of financial markets. As a wealth management analyst after college, I assisted high-net-worth clients in building and managing multi-asset class portfolios. Understanding not only stocks but also the intricacies of the bond market and alternative investments was crucial. Even today, as we primarily focus on equities, this panoramic perspective continues to be useful.
My career in wealth management led me to become one of the founding members of a boutique wealth management firm that grew to an AUM level of $3.5 billion over nine years. During my time as Deputy Chief Investment Officer, I faced the challenge of finding reliable stock recommendations. Despite having access to research from every sell-side firm imaginable, it was rare to come across research that we could trust. This prompted my brother and me to venture into private investing and share our equity research with a broader audience.
You write a lot about small-cap value which is a space with thousands of companies, many of which are cheap on metrics like price to earnings or price to book. What are you specifically looking for in a good investment idea? What are some common themes you have seen work well over time?
We've covered a good amount regarding small-cap stocks, although this is somewhat incidental when considering the distribution of market capitalization among exchange-traded stocks in the U.S. Presently, there are ~10,000 exchange-traded stocks, and roughly 70% are below a $300 million market cap. We're open to investing in larger-cap names when the right opportunity arises. While small-cap names are more likely to be underfollowed which could present an opportunity, a large or mid-cap name that is widely followed and very liquid may be more susceptible to narrative-driven selling and panic—Meta, for example, was a large position of our portfolio in the middle of last year and one we continued to add to as selling precipitated.
As private investors, we don't limit ourselves to a specific market cap strata. Our screening criteria are diverse, and we tend to favor screens with a high degree of turnover. These criteria include 52-week lows, decreasing debt levels, special dividends, declining revenue, a high D&A-to-Capex ratio, and low EV/EBITDA.
Assuming a stock isn't overpriced, what we seek in a promising stock idea is the potential for improving cash flow generation relative to the company's current state. Even if the company's current condition isn't ideal, if we can confidently anticipate a brighter future, we become enthusiastic. This predictability factor is how we define quality. A prime example is a landfill business. Most people might not view landfills as a high-quality business, but we certainly do. We are making more and more trash and are not keen on building more landfills. Landfill investors can sleep easy.
Our investment philosophy is one that we believe remains effective regardless of market regimes. However, if there's a prevailing theme, it's that Wall Street loves growing businesses – especially ones growing linearly -- and hates those that appear to be shrinking. If you can identify a business that people think is declining but is poised to grow stronger, you have substantial upside potential.
Zumiez is a well-run in-mall retailer with a long history of doing what a good retailer is supposed to do: turn a profit by selling exclusive things that people want while withstanding the heavily cyclical nature of the retail industry by maintaining balance sheet discipline. Zumiez is oversold and trades at roughly 5 or 6 times normalized FCF.
The issue with Zumiez is not operational in nature but rather is the way they attempt to return value to shareholders. Zumiez has bought back large amounts of stock at very high prices, effectively destroying value for ongoing shareholders. It’s the sole reason why their stock return has been anemic since they went public in 2005 – this de minimis total return is despite a 440% increase in store count, a 500% increase in revenue, and a 190% increase in normalized profits.
Misemploying buybacks isn't unique to Zumiez; it's a prevalent phenomenon across many companies. Many firms have thrown price discipline out the window when repurchasing shares because investors seem to start unconditionally clapping when they are announced. We have published extensive research on the matter and hope to see investors change their attitude to one that holds management teams and boards accountable for poor buyback practices.
What are some other compelling ideas on your radar now?
Edwin, I’m excited to share two beaten down and underappreciated ideas with your readers: