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Buying Marijuana Stocks in 2018 – Is it Too Late?

It was January of 2016 when we coined our first article on the marijuana investment theme, and since then things have blown up. The amount of interest we have had from first-time retail investors who want to buy marijuana stocks has far exceeded any other technology-related investment themes we cover here on Nanalyze. Part of the reason for this interest is related to how well marijuana stocks have been performing. The top marijuana ETF today, HMMJ, has performed quite well having returned +156% over the past year. (It’s now holding more than $750 million in investor funds.) That performance is small potatoes compared to how some of the biggest marijuana stocks have been performing lately. Here’s a look at how the top-9 stocks in the Horizon Medical Marijuana Life Sciences ETF have performed over the past rolling year:

1-Year Return 2018 Revenues (Est.) Market Cap
Aurora Cannabis ACB:CN +216% 0.049 5.95
Canopy Growth WEED:CN +488% 0.079 9.94
Aphria APH:CN +198% 0.037 3.26
GW Pharmaceuticals GWPH:US +31% 0.014 3.99
Scotts Miracle-Gro SMG:US -17% 3.984 4.25
Cronos Group CRON:US +424% 0.008 1.38
Hexo HEXO:CN +449% 0.004 1.11
Canntrust Holdings TRST:CN +290% 0.028 0.84
Organigram Holdings OGI:CN +203% 0.011 0.64

When interpreting the above table, please note the following:

  • All numbers are in USD billions
  • We estimated 2018 revenues by multiplying Q3-2018 revenues by four
  • We excluded The Green Organic Dutchman from the top-10 because it only recently had an IPO
  • Scotts Miracle-Gro (the world’s largest marketer of branded consumer lawn and garden products) made the list, but has clearly not been subjected to all the hype
  • GW Pharmaceuticals has been selling cannabis related therapeutics since 2010, and also hasn’t been subjected to the hype

Before we start getting too excited about these returns, we need to recognize that it’s impossible to tell if these returns are “good” unless we use a benchmark. In this case, we can use the Nasdaq index which would have returned +26% over the past year. On the other hand, the pure-play marijuana stocks seen above have returned an average of +324% over the same time frame. These returns are indeed good, but are they merited? Let’s turn to one of our MBAs for some textbook answers to this question.

The Efficient Market Hypothesis

In the boring world of finance, there is this notion about how all available information is already priced in when it comes to stocks. The best example of this comes in the form of “earnings surprises.” An example would be when a large company like Walmart announces better earnings than everyone expected, and the stock price jumps unexpectedly. In the case of marijuana stocks, the major news this past year has been around expanded legalization and interest in the sector from large alcoholic beverage companies. Recently, Constellation Brands (STZ) made an investment in Canopy Growth (WEED:CN) at around $48 CAD per share, and presumably, a fair amount of due diligence went into arriving at that number. Today, investors have ascribed a more than 30% premium to Canopy Growth shares as they trade around $63 CAD per share. It seems likely that Constellation would have paid a fair value (at least that’s what their shareholders are hoping), so we can assume that around $48 CAD per share is a fair price to pay for Canopy Growth shares today. Or is it?

Market Comparables

Today, Canopy is valued at nearly $13 billion. “Canadian Weed Stocks Might Be Too High” was the title of a recent article by Bloomberg which contained a good chart which shows just how highly-valued Canopy Growth is when compared to other popular consumer brands:

Canopy Growth Comparables

There’s another company valued around $13 billion called Molson Coors (TAP). (Some of you Americans out there might be familiar with Molson Coors. They’re the company that makes that watered-down piss you like to drink during sporting events.) Like Constellation Brands, Molson Coors is also looking at the cannabis drinks space. If we are trying to evaluate a company in an industry that doesn’t have benchmarks yet, we can use something called “comparables”. In other words, both Molson Coors and Canopy Growth sell products that would be considered “sin stocks” and which people are likely to buy in good times or bad. Both companies are about the same size, but that’s about where the similarities end.

Molson Coors brought in about $11 billion in revenues during 2017, while we’d be surprised to see Canopy Growth hit $80 million in revenues for 2018. In order for Canopy Growth to reach more than $10 billion in revenues, they would need 25% growth in revenues, every year, for 20 years. We haven’t even started talking about profitability, and already we can see how Canopy Growth has their work cut out for them when it comes to investors’ expectations of future growth.

Marijuana Stocks and Hype

One way to measure the popularity of a given investment theme is to look at how many Over-The-Counter (OTC) stocks or penny stocks try to attach themselves to said theme. (We’ve written before about how you should stay far, far away from OTC stocks.) In the case of Canadian stocks, it’s a bit tougher to differentiate the wheat from the chaff as they all trade on the same exchange. Take for example a company called Namaste (N:CN) which appears to be engaged in something we call “science by press release”:

Science by press release

Notorious short seller Citron Research put out an interesting take on this stock today which (assuming it’s all true) is downright scary. Namaste has a present-day market cap of nearly $600 million after soaring over +1,000% in the past year. After today’s Citron report, that may be the highest valuation they will ever see. Key takeaway here? You can’t just assume that large marijuana stocks are solid companies to invest in. Do your own due diligence, because it appears that few people are these days.

Another way to gauge hype is by looking at the frequency of Initial Public Offerings (IPOs) and the public’s reaction to them. We recently wrote about the Tilray IPO which ended up being priced at around $17 a share. Today, shares are trading upward of $100 per share. Are we really supposed to believe that the Tilray IPO was incorrectly priced, and that this “$10 billion company” is currently trading at a fair value? With the Tilray IPO having achieved the status of “best performing IPO this year-to-date” out of hundreds, expect to see more cannabis firms to follow suit – like Mary Jane’s Vape and Smoke Shop which filed an IPO this past week to raise $2 million for their “growth plans”. A cursory look at their filing shows that they have two retail stores today which realized revenues of around $110,00 for the first six months this year. Key takeaway here? Stay away from marijuana IPOs because investors are clearly being irrational when it comes to valuations.

Conclusions

People always like to ask the “is it too late to invest” question and that’s not the right question to ask. If you truly believe that marijuana as an investment theme will be so disruptive that it may someday be as large as the $223 billion in alcoholic beverages sold in the United States alone every year, then this is early days people. If you think this is the lowest these stocks will ever trade at, then back up the truck. Never purchase all your shares at once, but instead use something called “dollar cost averaging”. This means that when buying a stock, you should never buy it all at once. Instead, buy small fixed amounts over a pre-determined period of time.

What seems most likely is that we’re due for a meaningful correction in marijuana stocks. If such a correction comes along and you are holding long, just buy more if you really believe in the investment thesis. Experienced investors could try and play the short side of the trade now, but it’s not a good idea to bet against irrational people who are stoned out of their gourds. Not to mention, the costs of shorting a stock like Tilray right now are astronomical. As someone once said, the market’s irrational behavior will always last longer than the credit your broker extends for you to short stocks on margin.

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