YB Interview with Pernas Research

Hello and happy Sunday!

I hope you have had a great weekend so far. I’m super excited to bring you this awesome email with Pernas Research, two brothers who have crushed the S&P 500 since their inception in 2017.

The interview includes their:

• Background

• Investment philosophy and process

• Best investments

• Favorite stocks right now

• and more…

I just want to say thank you so much for reading and supporting Yellowbrick and the awesome investors we cover!

If you ever have any questions or feedback, I read every comment on every poll and every email you send me!

Thanks for your support!

Connor

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INVESTOR INTERVIEW

Today, I am very excited to bring you the second edition of our Yellowbrick Investor Interviews!

Today, I am chatting with Pernas Research, two brothers who run a stock research firm.

From the image below, you can see that they have crushed the S&P 500 since their inception in 2017, and even better, they share FREE write-ups every month to their email subscribers (link).

Tell us a little more about yourself and your background.

My formal educational background is in economics and statistics from UC Berkeley, and my former role was Deputy Chief Investment Officer of a family office that managed $3.5 billion of client capital.

I have always had entrepreneurial ambitions, and the opportunity recently came about to start a stock research business with my long-term investment partner and brother, Dean Pernas. We are of the opinion that there is a significant market opportunity for high-quality stock research providers for two reasons:

1. Increase in supply - of the 5318 companies trading on the Nasdaq and NYSE, 1169 are newly listed - having first traded within the past four years. Newly listed companies represent ~22% of these exchanges.

2. Passive investing has handily outperformed active managers to the point where there has been an exodus of talent and a dramatic reduction in research budgets. Systematic strategies have crowded out active ones.

I think this is an unpopular opinion and most would probably say that there is no shortage of stock research. But if you look at most of the research out there, it is either from wall-street-type institutions where the research is more “coverage” that often contains inherent biases or it is from “churn and burn” retail outfits that indiscriminately pump out stock ideas, cherry-pick their top-performing stocks for marketing, and often engage in other unethical tactics. So, in our view, there are very few trusted high-quality providers out there but perhaps we are just deluding ourselves. Ask me in a few years if the market opportunity is what we thought!

It is thrilling to embark on a new challenge, and I have always enjoyed risk-taking – both at the personal level and with my own capital. I think this started from my early days playing poker online and in card rooms, it wasn’t uncommon for me to play at a table for 15 hours straight. To the extent that investing is behavioral, I believe there is no better training ground than poker. You learn the value of continual constructive introspection and are constantly examining your own tendencies and decision-making. Once you start this excavation process, you realize how much of your decision-making is a result of emotion, convention, intuition, or any other non-conscious drivers. Sometimes intuition is helpful, but sometimes your intuition needs to be disassembled and rebuilt on an intentional foundation. The same process applies in investing, and there is a constant assessment of how much you know, why you know it, and why you feel entitled to be right against an ocean of market participants who might think differently. We have an intellectual love affair with what we do.

What kind of investor are you / what types of companies/situations are you looking for?

We are big believers in trying to understand every nut and bolt of the investment universe, but after you have gone through this process, it is essential that you simplify, simplify, simplify. So, we try to keep it simple, and what we look for falls into one of two categories:

1. Strong companies getting stronger

2. Not-so-strong companies that have a clear path to improvement.

If the future for a company is much brighter than the market expects and we are correct, there is an opportunity to make outsized profits.

Although we only play in developed markets, our portfolio has an optically odd assortment of types of names: growthy names, left-for-dead companies, small caps & mega large caps across a wide spectrum of sectors. It is safe to say that we are a far cry from coming even close to fitting in a style box.

We would classify our style as hyper-forward-looking. We care very little about past financial trends - the data is pretty clear that growth rates in the past have little to no correlation to growth rates in the future, so it is always a point of confusion when market participants use these trendlines as a support for their market views. For example, I can give you plenty of ways that the revenue growth you are seeing today will actually be at the expense of revenue tomorrow: a luxury company over-producing, a SAAS company hiding churn by being overly promotional, a widget company that has recently passed through too many price increases and has pushed their customers too far. Just to name a few.

In our opinion, the only way to truly have conviction in the future growth metrics of a business is to understand the full range of quantitative and qualitative factors such as technology, unit economics, competitive advantages, TAM, strategy (more on this below), etc, that allow the company to continue to exist and generate attractive returns for shareholders.

What does your investment research process look like?

We start with running a variety of different screens. The regularized screening includes 52-week lows, decreasing debt levels, special dividends, rights offerings, declining revenue, high D&A-to-Capex ratios, and low EV/EBITDA. In addition, depending on the current flow of fear-based narratives, we often find ourselves taking a fresh look at subsectors that experience rapid selloffs.

After pruning down our screens to a handful of names, we begin our deep dive research process which attempts to understand both the qualitative and the quantitative side of the business. The quantitative involves a study of the financials, unit economics, industry and macro data, and so on. The qualitative is talking to competitors, vendors, management, industry experts, former employees, and when possible, becoming users of the service or product ourselves.

Once we have enough of an understanding of the companies' future, we begin to construct “forward-looking” financials that we then use to calculate a company’s intrinsic value. This is an extensive and a leave-no-stone-unturned process. The best analysts ask all the right questions and have a resistance to well-sounding answers.

What do you think it takes to be successful at the style of investing you do?

One of the greatest golfers of all time, Ben Hogan, wrote a seminal book called “Ben Hogan's Five Lessons: The Modern Fundamentals of Golf.” The book was meant to communicate the necessary attributes a golfer must have to play well. To be clear, these attributes are necessary but not sufficient. If I were to try and compile a similar list for successful investing, I would list out the below (I rank them in order of importance):

1. Having a sense of good portfolio management. This is more important than being adept at analyzing companies. I think it was Soros who said, “It's not whether you're right or wrong, but how much money you make when you're right and how much you lose when you're wrong.”

2. Finding enjoyment in either the process, the competition, the intellectual stimulation, or whatever it is for you. I have known zero good investors who did not enjoy a large part of their day-to-day.

3. Behavioral understanding and control. An awareness of your own emotions, ego, impatience, and the many other subterranean drivers of your decision-making so you have a fighting chance at immunizing their impact.

4. Analytical ability and research stamina. Being able to thoroughly research, separate signal from noise, and synthesize effectively.

What are a few of the most successful investments you have made? (include a link to any work you did on them if possible)

Donnelley Financial (NYS:DFIN). We sized up this position at cost and although we have trimmed quite a bit, we still continue to hold it. DFIN is up over 600% since we originally published our research in July 2020. DFIN spun off from RR Donnelley in 2016. The company provides services and Regtech to public companies and investment companies (Mutual funds, ETFs, hedge funds, variable annuities) that must ensure compliance with the SEC. This was also a position that we sized up on heavily, given the low downside dynamics. It was being written off as a dying print business and was being outcompeted, and since its spinoff, the stock had done nothing but go straight down, but we could see that some of their SAAS regtech solutions were gaining adoption and their B2B brand was still incredibly strong in IPOs and M&A. Once the market cycle turned and IPOs started to come to market along with investors discovering a wonderful SAAS business, you got a huge rerating.

Below is a picture of the summary from the Yellowbrick website (link) or you can read Pernas Research’s full writeup here.

META – We originally entered the position in March of 2022 but then added heavily to the position in November later that year when sentiment was at its worst. There were a myriad of fears from regulation to TikTok to Zuckerberg having gone AWOL. The position is up over 300% since and was also a large position at cost.

Below is a picture of the summary from when they added to their $META holdings in November 2022 from the Yellowbrick website (link) or you can read Pernas Research’s full, original writeup from March 2022 here.

YELLQ – The first time we came across Yellow, I was immediately taken aback because it involved something I hadn’t seen before. The US Treasury owned 30% of the equity, this was a result of an equity kicker from a CARES act loan. Recession fears were heightened, and YELLQ was having all sorts of issues along with being heavily indebted. It was clear just from some basic napkin math that the terminals they have owned for many decades were worth significantly more than their carrying value, and even when taking into consideration all their debt, there was significant upside if this could be realized. But we needed a catalyst, and then 5 months later, a catalyst came, and Yellow filed for bankruptcy. We knew we had a white knight in the name of the US Treasury and quickly bought up shares. We are out of the trade now but made more than 400% on the initial cost basis.

Below is a picture of the summary from the Yellowbrick website (link) or you can search for YELL in Pernas Research’s stock sonar here.

What are a couple of ideas on your radar right now? (include any relevant links)

The FTSE (the London blue-chip index) is currently trading at roughly 17x P/E, while the S&P is over 24x. This discount is probably due to growth stalling in the UK, and inflation has been slightly stickier as a result of Brexit. Although we have to be selective, we are finding some healthy bargains in the UK. Below are two of the names we like.

*Note from Connor: I recommend using Interactive Brokers (link) to trade international and OTC stocks if you can’t trade them in your current brokerage.

Burberry-LON ($BRBY.L)

There are only a few luxury brands globally recognized for their enduring appeal: Burberry is one of these select few, having existed for over 168 years. Instances where such brands trade at a significant discount to their intrinsic value are rare. This occurs when the brand has some design mishaps or is undergoing some controversy. Fortunately, luxury heritage brands are very durable and can survive mismanagement. Burberry has been in the midst of a seven-year transformation aimed at elevating the brand and revamping its product offerings. These restructurings started with the previous CEO Marco Gobbetti in 2017 and continue with the present-day CEO Jonathan Akeroyd. Although elevating a brand is not riskless (Previous companies that attempted this and failed were Mulberry, which tried to make this leap with the ex-CEO of Hermès at the helm and quickly had to roll back prices when customers revolted), we believe Burberry has the heritage and the strategy to warrant a position. The current valuation presents an attractive entry point, and the stock has 50% potential upside.

Below is a picture of the summary from the Yellowbrick website (link) or you can read Pernas Research’s full writeup here.

DOCS-LON ($DOCS.L)

Doc Martens (DOCS) is a UK-based boot brand that has sold off 80% from its overpriced IPO in January 2021. The brand has experienced a recent revenue decline driven by several short-term operational and inventory mishaps along with general cyclical challenges in the footwear category. The operational and inventory challenges are now fixed, and it is more likely than not that the footwear category will improve within the next 12 to 24 months. The market is attributing this revenue decline as a possible impairment to the Doc Martens brand, but we think this couldn’t be further from the truth. DOCS is a strong brand with an enduring appeal across genders, regions, cultures, and socio-economics. The market is also discounting any growth opportunities DOCS has, of which we think there are several. In sum, this is a company that will grow stronger but is priced for the opposite. Given the pricing opportunity and the underlying resilience of the brand’s strength and growth opportunities, DOCS has a total return potential of more than 60%.

Below is a picture of the summary from the Yellowbrick website (link) or you can read Pernas Research’s full writeup here.

What do you hope the future looks like for yourself and your career?

We hope to be respected as an organization that is unbelievably good at what they do, ultimately furthering our reach as a gold standard for trusted research in the financial industry.

Who are some other investors, Twitter accounts, blogs, funds, etc that you follow (and why)?

I am grateful to Aswath Damodaran for all the research he has made public over the years. There are few people who have tried to add to valuation theory as much as Aswath, and I do not believe he gets enough credit for this. In addition, other investors we value: Buffett, Munger, Druckenmiller, Tepper, & Peter Lynch. Any interviews, books, and writings from these investors are a must.

Some Twitter accounts that are terrific:

Dalius @InvestSpecial is a must-follow – he continually provides great resources on who to follow, and where to find interesting research. Additionally, he runs a great special situations subscription business to which I am subscribed.

Andy @evfcfaddict – I love his Twitter spaces, and he often brings together fund managers for interesting discussions. (note from Connor: I interviewed Andy a couple of weeks ago. You can read that here)

Edwin Dorsey @stockjabber – Provides great resources for investors along with writing interesting content on short ideas.

@Toffcap – Always tweets value-add investing tidbits and has a “Monday Monitor” blog packed with highly relevant event-driven info.

Andrew Walker @andrewrangeley– Produces high-quality investing interviews that he posts on YouTube. He has a blog that is quite entertaining and value-add.

Where can people find your work? Any other specific content of yours that you’d like to share?

Our Twitter handle is @pernasresearch, and the best way to follow us is by adding your email to pernasresearch.com to receive our research. Below is what we send to our readers.

• On the first of every month, we send a ~2000-word stock write-up along with an attached summary.

• Once a quarter, we send our Quarterly Performance Letter.

• Every Wednesday, we send our 'Stock Sonar,' which has brief and sometimes actionable takeaways from the top three companies we researched.

• Ad hoc: A few times a year, we send updates on any material adjustments in our portfolio.

Thanks again, Connor, I always appreciate our conversations, and thank you for the help you have provided in guiding our research and marketing efforts.

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Thank you so much to Pernas Research for doing this interview. They are easily one of the best research teams sharing content publicly (signing up for their newsletter is a must) and you’d probably make a few extra bucks investing in some of the stocks they highlight.

I also put up a Pernas Research author page on Yellowbrick (link) with a bunch of their stock pitches, their overall returns on their stock pitches, and more (link).

If you enjoyed this interview, feel free to share it on Twitter and with other investors who would enjoy it.

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THANKS FOR READING!

Thank you so much for reading and supporting this email!

Connor (@connorvo on Twitter)