Idea Brunch with Justin Dopierala of DOMO Capital
Justin Dopierala shares his research process, his top ideas, and why he invested in GameStop in 2019
Welcome to Sunday’s Idea Brunch, a weekly interview series with underfollowed investors and emerging managers. We are very excited to interview Justin Dopierala!
Justin is currently the portfolio manager of DOMO Capital, a state-registered investment advisor he founded in Germantown, Wisconsin. Firm assets have grown from a few hundred thousand to over $50 million as of November of 2021. Since its October 2008 inception, the DOMO Concentrated All Cap Value Composite has returned 20.4% annualized net of fees compared to 14.3% annualized for the S&P 500 Total Return Index through Q3, 2021. DOMO Capital is up over 64% this year net of fees according to its most recent investor letter.
Justin, how has your experience been launching a state registered investment advisor, and what has contributed to your strong performance?
Using a separately managed account structure as an investment advisor to run an investment strategy/composite is the future, and we feel lucky to have been early in that trend by starting the company back in 2008. Unlike hedge funds that take custody of client assets, we’re able to replicate our strategy for each client in an account in their own name. This creates a lot of efficiencies and also eliminates a lot of risk to the client since TD Ameritrade is the custodian, not DOMO Capital.
Our strategy is based on the belief that diversification is riskier than concentration as long as you do not equate volatility with risk – which we do not. We believe the reason that so many mutual funds cannot outperform the index they measure themselves against is because they have their assets diversified across hundreds of stocks. There is no way that they believe their 100th or 200th idea is as good as their top ten ideas and yet they’ll have roughly the same amount of capital allocated between them. We believe that allocating capital towards investments that you do not have as much conviction in simply to avoid volatility is a flawed concept.
We typically only invest our clients in our best five to ten ideas and if we can’t find any opportunities, we’ll hold cash and be patient. We view volatility not as risk, but as an opportunity to rebalance our positions and to add to stocks during periods of time that the market is overreacting to news in the short-term that doesn’t impact the long-term thesis.
You were prolific in writing about GameStop’s potential. In early 2019 you advised management to buy back stock and correctly predicted that a new console cycle would help the company. What happened at GameStop why did the market get the company so wrong?
You’re right, we were prolific in our writing, and this will actually be featured in a theatrical documentary that should be released fairly soon. In short, GameStop didn’t have a revenue problem, they had an expense and footprint problem. Management was doing a very poor job of managing S&A and they needed to aggressively reduce the store footprint.
What the market didn’t see was that a lot of GameStop’s losses were non-cash losses due to write-downs and that most of the revenue declines were actually due to asset divestitures (which were actually a great thing and occurred at levels much higher than the market expected).
I’m not sure if the market necessarily got GameStop wrong, but the media and the short sellers certainly did. As short sellers shorted over 100% of the shares outstanding, they drove the stock down to incredibly unrealistic levels. At one point we were buying GameStop near $2.60 per share. At that price, GameStop was trading at half of its net cash position! They could have paid off all of their term debt and still had $5 per share in cash. We have no idea what the short-sellers like Melvin Capital were thinking or what sort of due diligence they did. Some sites, such as Seeking Alpha, had authors constantly talking about a shift from physical to digital games, but most of them didn’t even understand the statistics they were quoting. Statistica was the main source they used, but they didn’t realize that the major shift was simply due to Statistica starting to include mobile downloads/games into the mix. In other words, there wasn’t actually a major decline in physical games, there was just an increase in people playing free games on their phones. At the time, the vast majority of gamers preferred physical games for use on their consoles. If the short sellers had done a deeper dive on console-only sales mix their conclusions would have been completely different which we highlighted to our readers repeatedly from 2019 to 2020.
An accounting rule change is another thing that may have confused the short-sellers, not only on GameStop, but on other retail stocks as well. Within the last couple of years, leases were suddenly reported as debt on the financial statements, making it appear that retailers had much more debt than in the past when in reality, nothing had actually changed. One of the things that made GameStop a no-brainer is the fact that most of their leases were expiring within 2 years. This gave them incredible flexibility to downshift fast in the future which is the exact opposite situation that occurred when RadioShack went bankrupt due to their creditors forcing them to keep a large store footprint.
I’m not sure if people also understand how many assets GameStop still owned. They were able to sell their corporate jet and they also owned a lot of their own facilities which they eventually were able to sell and leaseback. If management had been more competent at the time, they would have listened to their investors and sold their international division as well, but once COVID hit that became impossible.
You’ve developed a 40,000+ Twitter following and seem to have a knack for understanding the “Wall Street Bets” trading sentiment. Can you tell us a little about that?
We’re not sure that DOMO Capital has ever been associated with “Wall Street Bets.” As you noted, we wrote prolifically about GameStop and when we created a Twitter account people remembered that and followed us. Therefore, it is true that a lot of our followers have found us through our GameStop research and are likely “retail” investors. We do our best to be honest and transparent with our followers, and I think that is actually what they appreciate. Our followers appreciate that a professional investment firm is willing to call out the media when they distort the facts (several news organizations had to change their news reporting on GameStop after we called them out, such as Bloomberg), and they appreciate that we are willing to engage with them in a relatable way. DOMO Capital was built on the back of retail investors. 99% of our clients are retail clients with our single institutional client being Concordia University Wisconsin, my alma mater. Now that we have cracked $50 million in assets under management, we think that gaining institutional clients in the future will become easier as our AUM was always a sticking point in the past despite our incredible performance. However, we’ll never forget our roots, and we’ll always be on the side of retail investors and willing to share our knowledge and expertise when we can.
What are one or two interesting ideas on your radar now?
A couple of our favorite ideas right now are Alto Ingredients (NASDAQ: ALTO — $341 million) and Pitney Bowes (NYSE: PBI — $1.17 billion).
Alto Ingredients seems like the biggest no-brainer right now. Ethanol fuel crush margins have spiked to incredibly high levels (highest since 2014) which is going to generate tons of cash for ALTO and that wasn’t even part of the original thesis, it is just icing on the cake. It is stunning to see the stock trading where it is. ALTO used to be called Pacific Ethanol and they primarily just sold ethanol as fuel. They almost went bankrupt, but they were able to transform the business just in time to produce specialty alcohol, which led to a massive sales increase due to COVID sanitizer demand. A year ago, ALTO had debt with a double-digit interest rate, but the company is now completely term-debt free. The market is ignoring how the business has transformed and is fixated on the reduction in sanitizer sales. ALTO has done a great job of growing their specialty alcohol and getting licenses to be able to put ethanol into products, such as pharmaceuticals, that one else in North America has the licenses to do. As they completely lap COVID the market will start to realize how durable the specialty alcohol business is and since it is not as commoditized as fuel, the margins are significantly better. ALTO has also started to upgrade its facilities to make even more money selling essential ingredients and protein. Lastly, they are set to announce a carbon sequestration plan within months that the current legislation in Congress would make even more lucrative. ALTO has a clear path to earning over $100M in EBITDA a year going forward and the current market cap of less than $400 million makes little sense. However, that’s just how value plays work sometimes… the market needs to see the actual print before it’s willing to believe. There’s also a fairly large amount of short interest in ALTO (over 15% of the float) and insiders have been buying a lot of shares recently.
We did a long write-up on Pitney Bowes on Seeking Alpha earlier in the year when the stock was in the low $7’s. It immediately spiked to over $13 per share shortly after our article was posted, but is now trading in the mid $6’s. We would point people towards that article, but it would be really hard to do any better job than the brief summary that Miller Value Partners put in their Q3 2021 investor letter:
"Pitney Bowes (PBI) was also a recent laggard off nearly 20% during the quarter. The company has been building out an E-commerce business for the past 10 years that is approaching $2B in revenue and growing revenues longer-term at a double-digit pace. With the E-commerce segment approaching scale, management has significant new initiatives underway to help improve the segment’s profitability to normalized levels (8-12% EBIT margins) over the next couple of years. Success on achieving normalized profitability for the segment would dramatically enhance Pitney Bowes earnings (>$1 in EPS) and annual free cash flow generation (>$250M). Last quarter we highlighted, the digital service business within Pitney’s E-commerce segment and the significant embedded value that was suggested by recent acquisition of a direct competitor Stamps.com at 8x revenue. However, another recent market transaction suggests the E-commerce business has even greater embedded value. At the end of the second quarter, Global-e (GLBE), a UK company that focuses on cross-border business came public at $25/share or approx. $4B market capitalization. The initial IPO price suggested, 2021 Enterprise value to Revenue >20x. Since the IPO, GLBE has climbed to greater than $50/share. Within Pitney Bowes’s E-commerce segment there is a much larger cross border business representing approximately $500M in revenue. The current valuation of Global-e suggests Pitney’s cross border business is worth significantly more than the company’s current market cap. With the marketplace valuing many businesses in excess of 10x revenue, we believe that Pitney Bowes shares remain significantly mispriced at only .35x of revenue and >30% normalized earnings and free cash flow yield. In our opinion, the shares are becoming increasing attractive as their E-commerce segment appears to be significantly undervalued and has the potential to unlock significant equity value over the next couple of years."
Justin, what are some of the first things you do when researching a company? What does that first hour of research look like for you? Do you do anything that few others do?
We have a proprietary algorithm that helps us identify potential opportunities. We are value investors, but what might set us apart from other value portfolio managers is that we aren’t just looking for “cheap” stocks. We’re looking for stocks that are cheap unto themselves compared to the multiples they traded at previously. Then we think, why has the market’s perception on the stock changed? The answer to this is very important; it is absolutely essential to correctly identify why the market sentiment is poor, because sometimes it’s not what you may initially believe to be the case. Next, you have to have a keen business sense to correctly determine if the company can fix or correct the issue of concern. My experience as an internal auditor has greatly contributed towards my ability to make these assessments. Most of the time, the stocks are trading at a discount for an appropriate reason and may never recover. We try to find the situations where instead the market is just falling under the behavioral psychology flaw of recency bias. In other words, market participants tend to put too much emphasis on the most recent news (such as a quarterly report or a temporary, one-time fixable problem). This recency bias can result in stocks trading at both significant discounts and significant premiums.
If we believe that market sentiment can be changed in the future, we try to identify what the catalysts will need to be to change the market’s perception about the stock, and then we try to determine how timely each catalyst is likely to be. We then make a determination of how much we want to weigh the portfolio into the position based on our level of conviction. A 5% position is typically our bare minimum to put into a name, and we can add to a position as high as 20% of the total portfolio; however, if a stock continues to appreciate, we do not have any arbitrary limits that would force us to sell simply because it has become a larger and larger position within the portfolio.
Are there any common red flags or bullish signs you look for in your shorts and longs?
We never short stocks – we believe that is a waste of capital. The market is rigged in your favor (there is no limit to how much a stock can rise, and the odds of losing 100% of your investment in even a single position is fairly low). Why would you want to flip that and cap your gains at a percentage less than 100% and take on unlimited risk? We’d rather just focus on our best long ideas. One of the biggest red flags is when management is not being transparent or even worse is being outright manipulative. That doesn’t mean that it’s not a good investment, it may actually increase the odds of an activist, but it does give us pause. Insider buys are always a bullish sign in our view.
What would you like DOMO Capital to look like 10 years from now?
DOMO Capital doesn’t have to look much different in 10 years than it does now except perhaps we’ll have a few more employees and hopefully instead of $50 million under management we’ll have billions to manage!
Justin, thank you for the great interview! What is the best way for readers to follow or connect with you?
People are always welcome to follow us on Twitter at @DOMOCAPITAL but the best way to reach us is through our website or over email: Justin@domocapital.com
If you enjoyed this Sunday’s Idea Brunch interview, please forward it to a few friends and encourage them to subscribe! And if you have feedback or want to suggest a great investor we should interview, please hit reply.
This newsletter is not investment advice and is for informational purposes only. You can reach the publisher by email at edwin@585research.com or on Twitter @StockJabber. This article is for premium subscribers of Sunday’s Idea Brunch newsletter. If this article was forwarded to you, please consider becoming a premium subscriber to receive interviews like this one every Sunday. Learn more here.