Proponents of the marijuana sector say it is the ultimate growth industry. Opponents suggest it does not represent a value investing opportunity. In their eyes, sales growth is below the expected level. At the time of writing, marijuana is legal in 33 states plus D.C. It is recreationally legal in 11 of these states plus D.C. Canada fully legalized cannabis in 2018.
The existing expansion, with the promise of more to come, has led to some 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 industry now seems like a no-brainer – even if it still has a long way to go! In this guide, we look at the good and bad of marijuana investment.
Marijuana Stock Investment – The Basics
As far as investing goes, you need to concern yourself with three types of cannabis companies:
- Growers: Those who cultivate marijuana 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.
- Ancillary Product & Service Providers: These businesses provide crucial products and services to the weed industry. Examples include 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.
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
Value investing is a viable way to achieve your financial goals regardless of the industry you invest in. 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 WayofLeaf 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!
3 Reasons Why You Should Consider Investing in Marijuana Stock
1 – Hype over Stocks Outweighs Performance
One suggestion is that cannabis stock prices have reached the bottom. Therefore, a rise in share prices is inevitable.
Cannabis stocks mainly enjoyed a good spell of growth from mid-2017 to approximately March or April 2019. However, it has been mostly downhill ever since. This boom was primarily hype, and soon enough, many investors started to realize that marijuana is just a crop.
Canopy Growth is a market leader, and its share price is close to 22 CAD (Canadian Dollars). However, it was worth over 67 CAD at its peak. It may have recovered from 15 CAD back in March of 2020, but it still has a long way to go. We can say the same for every other pot stock. There is no guarantee that these share processes will recover.
2 – Limited International Expansion
Proponents of marijuana suggest that there are a vast number of strains and products available. As a result, the market should continue to expand. However, this doesn’t take into account that weed is just another commodity. Like fruit and vegetables, for example, personal tastes dictate what people buy.
While MMJ is legal in several countries, only Uruguay and Canada allow adult use across the country. Mexico may follow suit in the next couple of years. However, the continuing problems with legality are sure to put a cap on international growth.
3 – The Fundamental & Technical Data Doesn’t Bode Well
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 and need every dollar of the money at their disposal.
Although companies like Canopy Growth expect to see a profit in 2021, it hasn’t yet happened.
If you go through these firms’ books 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 18. It has increased from a terrible rating of 7 but has a LONG way to go.
For reference, the max level is 99. Canopy Growth’s EPS score is just 20.
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 among the best rating of any pure-play cannabis producer at 52.
Final Thoughts on Whether You Should Invest in Marijuana Stocks in 2021
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.
Investment experts at The Motley Fool recommend the following cannabis companies if you’re thinking of investing:
- Green Thumb Industries
- Trulieve Cannabis
- Scotts Miracle-Gro
- GW Pharmaceuticals
- Innovative Industrial Properties
Increased competition, supply problems, too much stock, and cash flow problems will continue to plague the industry for the foreseeable future. Currently, it is hard to tell the likely winners. There are arguably no stocks in the 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. 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.