Proponents of the marijuana sector say it is the ultimate growth industry. Opponents suggest it does not represent a value investing opportunity because sales growth is below the expected level. At the time of writing, marijuana is legal in 33 states plus D.C., and recreationally legal in 11 states plus D.C. Canada fully legalized the herb in 2018.
The current, and likely future, expansion of cannabis’ legality – not just in North America, but also in Europe – has led to some pretty fanciful predictions. The CEO of Tilray, Brendan Kennedy, stated that weed was a $150 billion industry. Bruce Linton, now the ex-CEO of Canopy, went further by suggesting the cannabis market could one day reach $500 billion.
Linton bases this prediction on the size of the tobacco and alcohol markets. Outside of China, the global cigarette market is worth approximately $680 billion per annum. The global alcoholic beverages market is worth up to $1.5 trillion. As it happens, Constellation Brands, a massive player in the alcoholic drinks market, has invested $4 billion in Canopy.
If these figures came to fruition, investing in the marijuana market now seems like a no-brainer. But wait! The global marijuana market was worth less than $10 billion in 2017. Most research suggests a likely market size of $32 billion in 2022. Therefore, it has a long way to go to reach the lofty predictions of individuals who are biased because they are in the industry!
In this guide, we look at the good and bad of marijuana investment.
Marijuana Stock Investment – The Basics
We’re assuming that you know a little something about the industry. If not, feel free to browse WayofLeaf and learn more. As far as investing goes, you need to concern yourself with three types of cannabis companies:
- Growers: Those who cultivate the herb indoors, outdoors, or in a greenhouse facility.
- Biotechs with a Marijuana Focus: These organizations develop prescription drugs based on cannabis ingredients. Examples of these drugs include Sativex and Epidiolex, which contain synthesized THC and CBD, respectively, as their active ingredient.
- Ancillary Product & Service Providers: These businesses provide crucial products and services to the weed industry, such as lighting and hydroponics systems.
If you have investment experience, you’ll already know how to perform due diligence on a company. If not, here are a few quick tips:
- Analyze the track record of executives in similar industries.
- Check out the company’s rivals to see how it stands out within the industry. What competitive advantages does it have?
- Find out how the business intends to grow and expand.
- Dig deeper into the firm’s books. Finding a profitable company in the marijuana industry at this stage isn’t easy. If a company is not yet profitable, investigate how it intends to reach a level of profitability.
While we will not go into these terms in this article, you need to check for the following figures, and understand what they mean:
- Free Cash Flow
- Price-to-Book Ratio
- Revenue Growth
- Analysis of Sales
Value Investing is the Smart Play
Whether you want to invest in marijuana stocks or shares in another industry, value investing is a viable way to achieve your financial goals. It is the process of purchasing undervalued stock. If you are a value investor, you aim to buy stock for less than its intrinsic (essential, true, and inherent) value.
Let’s imagine that you could buy WayofLeaf stock for $25 a share. After a thorough analysis of the brand, you determine that it is worth $45 a share. Therefore, you buy it at $25 in the belief that it will rise. If you go down the value investing route, make sure you have a ‘margin of safety.’ This term relates to the practice of buying a stock for well below its actual value.
One of the fathers of value investing, Benjamin Graham, only purchased a stock if it was worth no more than 2/3 of its intrinsic value. In our hypothetical example, Graham would only consider buying stock in MarijaunaBreak if the share price was $30 or below.
For the record, believers in the Efficient Market Theory suggest that value investing doesn’t exist. Tell that to the likes of Warren Buffett, who has made his fortune from beating the market!
Why You Should Consider Investing in Marijuana Stock
A Growing Market
According to Forbes, the cannabis industry was worth over $9 billion globally in 2017. Estimates vary, but its value could increase by at least 400% within the next decade. In any growth industry, there are investment opportunities. The trick is finding the winners and separating them from the failures!
Potentially Underpriced Stock
As you will see in the ‘why you should not invest’ section, this reason is subjective. Several major marijuana stocks fell significantly in 2019. Here are five examples:
|Stock||Current Price||Price at Start of 2019||Peak 2019 Price|
|Canopy||24.06 CAD||39.28 CAD||69.90 CAD|
|Innovative Industrial Properties||$78.03||$45.91||$137.62|
|OrganiGram||3.40 CAD||5.67 CAD||10.72 CAD|
We could include many more marijuana share prices. The story is the same almost across the board. There is no question that anyone who invested either at the start of 2019 or during the peak of the market, has taken a bath. A few investment experts believe that marijuana stocks are undervalued due to the scale of the sell-off.
Fewer Catastrophes on the Horizon (Probably)
Many cannabis companies have experienced significant problems during the year that hurt share prices. Here is a quick sample:
- Canopy’s board removed CEO Bruce Linton in a stunning move that spooked investors.
- The province of Quebec implemented restrictions on edibles due to a fear of children eating them.
- Many companies reported weak quarterly results, which generated a sell-off of shares.
- CannTrust, a marijuana supplier, was nailed for growing in illegal labs. Predictably, share prices plummeted.
One would expect (or hope) that the industry will not experience such a tumult in 2020 and beyond.
More Clarity in the Industry
As weed remains federally illegal, we are reliant on a mish-mash of confusing and often contradictory laws at both local and state levels. For example, some states claim that CBD is illegal, yet it is widely sold across America. Noise from Washington suggests that the nation’s politicians are coming around to the idea of following Canada’s lead.
In November 2019, the House Judiciary Committee voted to approve the Marijuana Opportunity Reinvestment and Expungement (MORE) Act. It is the first time in U.S. history that a congressional committee passed a cannabis legalization bill. The Act will effectively end weed prohibition in the United States. While it almost certainly won’t make it into law right now, a change in Administration could make legalization a reality.
It is also possible that the SAFE Banking Act will make it into law. If it does, the legislation will finally allow banks to get involved in the sector legally. Having access to banking would only strengthen the industry.
One of the keys to any growth market is versatility, and weed has that in abundance. Aside from marijuana flower, there is cannabis and CBD oil, edibles, topicals, beverages, bath bombs, and much more. The herb is still federally illegal and not permitted in 17 states. In total, 39 states don’t allow recreational cannabis. Imagine a situation where a growing number of marijuana products become legal to hundreds of millions of people.
Why You Should NOT Invest in Marijuana Stocks
Even in states with medical or recreational marijuana programs, there are issues with supply. Illinois is the most recent addition to the list of recreational weed states, but it is having problems preparing for the new market. Illinois became the 11th state to allow full marijuana legalization in June 2019.
However, relatively few dispensaries have received licenses. As a result, prospective customers face a long journey to find a place that sells the herb. It is the same story in numerous states, and also in Canada.
Our northern neighbors legalized cannabis in October 2018. By the beginning of 2019, Health Canada had to go through over 800 license applications. It is going to take a long time to review the backlog. An example is Aphria, who received approval to plant at its Aphria Diamond location some 21 months after filing its application.
Initial Proponents Have Climbed Down
CNBC’s Jim Cramer initially suggested that the market was a great opportunity. In November 2019, he backtracked by saying, “the marijuana industry is just not what it was cracked up to be.” He pointed out the structural problems in Canada and the fact that herb floods the market.
Cramer suggested that investors downsize their holdings because it is not a market ripe for investment. His sentiments are echoed by many investment experts who feel that there are too many issues to contend with at this point.
Major Companies Are Diluting Shareholders
Firms such as Cronos Group and Canopy Growth have landed substantial equity investments. However, companies such as Aurora have not and are instead reliant on organic growth and acquisitions. With cash-flow problems, Aurora is issuing its common stock as collateral to finance almost all of its buyouts.
When you issue stock, you dilute existing shareholders. In Aurora’s case, if it continues to experience losses (which is the reported outlook for 2020), it will further weaken its stock, and its cash position will get worse. Aurora is far from the only marijuana company in this situation.
Is the Market at the Bottom?
The suggestion is that the marijuana market has almost hit its bottom, and a rise in share prices is inevitable. Aurora, for example, is now at its lowest stock value since November 2017. Despite a slight recent increase, Canopy is trading at around its lowest value since December 2017. Across the industry, most marijuana stocks are at their cheapest level for at least a year.
While cannabis stocks mainly enjoyed a good spell of growth from the middle of 2017 to approximately March or April 2019, it has been mostly downhill ever since. This boom was primarily hype, and soon enough, a lot of investors started to realize that marijuana is just a crop.
There are now more weed stores in the United States than Walmart shops! Greater legalization has hurt prices as new firms enter the market. In states such as Oregon, there is already enough weed to last for over six years, and it continues to grow! In all likelihood, only a handful of cannabis stocks will rebound while the rest will die in the water.
The Fundamental & Technical Data Stinks
Leaving aside any bias you have for or against the cannabis industry, a savvy investor always looks at the data and decides without emotion. At present, despite the seemingly massive growth, the marijuana industry is losing money at an alarming rate. The rapid expansion means producers are burning through their cash in a bid to keep up. As we mentioned above, big firms such as Aurora have cash problems, even though it is now reported to have $750 million at its disposal.
While sales growth has increased, it is doing so at a much lower rate than anticipated. The Big Four cannabis firms (Canopy, Cronos, Tilray, and Aurora) lost a combined $14 billion during Q3 of 2019.
If you go through the books of these firms and calculate some of the values we mentioned earlier, they don’t look like value investments. For example, Tilray stock has an Earnings Per Share (EPS) rating of 7 – one of the worst possible! For reference, the max level is 99. Innovative Industrial Properties leads the weed field with more impressive EPS of 88.
According to IBD research, you should not invest in stocks with a Composite Rating (on the major U.S. stock exchanges) of under 90. In case you were wondering, this rating is a combination of the following five IBD ratings:
- Relative Price Strength
- Sales + Margins + ROE
- Industry Group Rating
Cronos has the best rating of any pure-play cannabis producer at just 28! Innovative Industrial Properties has a rating of 86, but its shares have tumbled since July 12 when it priced a new Public Share Offering.
Final Thoughts on Whether You Should Invest in Marijuana Stocks in 2020
Ultimately, the existing data suggest that investors are unwise to see the whole cannabis industry as a growth market. While there is no question that the sector will expand, profitability is another story. Your best bet is to find one or two firms that will bring profit to investors.
According to Investopedia, the following stock options are among the best value in the industry:
- Village Farms International Inc.
- Amyris Inc.
- iAnthus Capital Holdings Inc.
Back in August 2019, Motley Fool suggested these five stocks:
- Origin House
- OrganiGram Holdings
- KushCo Holdings
- Innovative Industrial Properties
- Constellation Brands
Of these, only Constellation Brands has not experienced a considerable downturn. That’s because it’s primarily an alcoholic beverage company!
Increased competition, problems with supply, too much stock, and cash flow problems will continue to plague the industry in 2020. Currently, it is hard to tell the likely winners. There are arguably no stocks in buy range because the majority are in deplorable shape. Almost all are at or near a low, and there is no way of telling if any have reached the bottom.
It is best to avoid any weed company with poor financials because they may not have the capacity to navigate the upcoming storm. If you must invest in cannabis stocks, focus on firms that show an ability to turn a profit. There are potentially profitable marijuana stocks; the hard part is finding them!
Finally, we wish to remind you that this site is NOT an expert in finance and investing in ANY industry is a risk. We take no responsibility if you earn or lose money from your investment. If you’re considering pushing money into marijuana stocks, perform a thorough analysis of each firm’s technical and fundamental data. Alternatively, hire a financial expert to do so on your behalf.