The Puzzling Paradox of Marijuana Stocks

As a consequence of producing insightful articles on disruptive technologies, we need to articulate to lots of startups and venture capital firms what we do. Having to explain why we write about 11 categories of disruptive technologies + marijuana is tricky. Few would consider marijuana legalization a disruptive technology, but we started covering marijuana stocks anyways because there is so much interest from our audience. In particular, we find the theme often attracts first-time investors.

First-time investors are great because you can immediately tell them truths they will never hear from mainstream pundits, the lessons we all had to learn the hard way. You will not find “the next Microsoft,” most over-the-counter stocks fail miserably, and real wealth creation is boring AF and takes loads of time. It’s about time in the market, not timing the market. The same holds true for marijuana stocks – at least that’s what we thought.

Holding Pot Stocks Long and Strong

We have no present exposure to the cannabis industry. In the past, we dabbled a bit in the Horizons Marijuana Life Sciences Index ETF (HMMJ), and Charlotte’s Web (CWEB), both of which we since exited. That’s because we believe the risk is not worth the potential rewards. A large number of irrational retail investors and incredibly-high regulatory risk create a market that’s extremely volatile and emotionally difficult to navigate as a result. A prudent way to invest – not speculate – in anything this volatile is to buy an ETF or some quality stocks and forget about them for a while.

Regarding marijuana ETFs, we’re not impressed with the rigor at which constituents are being vetted (examples here). An entire Canadian stock exchange was nicknamed the “Cannabis Securities Exchange,” and just about everyone pivoted their business towards cannabis. Having so many new entrants makes it difficult to distinguish between good marijuana stocks and bad, not to mention most marijuana companies have corporate structures that are extremely convoluted, something that results from the inability for companies to conduct business across state lines. (Cannabis remains illegal at the federal level, though an increasing number of states are legalizing it.) While cannabis remains unregulated, it’s easy to run shoddy operations – thus the proliferation of marijuana penny stocks that are largely total failures. Some are downright scams, and we’ve publicly reported them to the SEC, only to have our complaints fall on deaf ears.

As with any thematic investment, we can simply pick the largest ETF in the space and see how it performs relative to the broader market in order to gauge how the overall marijuana industry has been performing. That happens to be the ETF we covered in our last piece on “Cannabis Stocks Come Crashing Down to Earth,” ETFMG Alternative Harvest ETF (MJ). Here are some interesting numbers.

  • If you purchased shares when MJ was first available, you’d be down -56%
  • If you purchased shares of MJ at peak cannabis hype, you’d be down -71%
  • If you purchased shares of MJ exactly one month ago at the absolute bottom, you’d be up +26%.

In other words, MJ has performed very poorly, hitting all-time lows last month.

Now, here’s something that really doesn’t make sense. Remember how we taught you a trick to see how any stock has been impacted by COVID-19? Turns out that MJ has lost -32% since COVID-19 began impacting society, something which hardly adds up. We’ve been reading about how marijuana sales across the nation have soared, almost tripling in some places.

Credit: Key Investment Partners

If recreational marijuana sales are going through the roof, why is the biggest marijuana ETF out there performing so poorly? When we consult the experts, none of this seems to add up.

The Impact of COVID-19 on Cannabis Investors

A cannabis venture capital firm called KEY Investment Partners invests on behalf of some of the largest pension funds and endowments in the world. Consequently, they produce some well-researched reports on the cannabis space, one of which we highlighted in our recent pieces on Investing in the Ancillary Cannabis Sector and The Impact of Cannabis on Scotts Miracle Gro.

KEY recently produced some research around the impact of coronavirus on the cannabis industry saying that it could actually “accelerate legalization” as states look to shore up their budgets with additional tax revenues. With cannabis being deemed as an “essential business,” sales have been booming. States like Colorado are said to be easing restrictions, allowing doctors to prescribe medical marijuana by phone, or allowing curbside pickups. People who were jailed for puffing chronic in states where marijuana is criminalized are being set loose, raising some questions around whether they should have been jailed in the first place. Suddenly, there are more important things to worry about.

KEY Investment Partners is doing a lot more sophisticated investing than just a long/short strategy in stocks and ETFs. They’re in the business of private equity, which means they’re accessing deals that typically belong to institutional investors. Now that we’re going through a “valuation reset,” they think it’s a great time to put money to work. In their words, “investors with deployable capital have the advantage of investing at the bottom of a cycle.” A lot of smart money was on the sidelines wanting to get exposure to this new category of stocks that – similar to other sin stocks – seems resilient to recessions. Now, they can have the pick of the litter along with the best terms. Everyone needs money, and only the best will end up raising it.

For retail investors who may not have the net worth to place money with a venture capital firm, access to marijuana stocks and ETFs remains the only option for getting exposure to the marijuana growth story. The advice given by KEY still applies – invest in strong brands that will thrive when people gravitate to what they know. In times of uncertainty, people find comfort in what they know. Having a strong brand across multiple states makes it easier to run national advertising campaigns and dominate markets if federal legalization happens.

The Importance of National Cannabis Brands

In February of this year, we published a piece titled The Importance of National Cannabis Brands in which we wrote about Cresco Labs which aims to build “the most important cannabis company in the United States.” With a tenured management team at the helm, Cresco is growing fast by making strategic acquisitions. In today’s environment where funding has dried up, there will be lots of fire sales happening as over-extended cannabis companies desperately try to survive, the ultimate mandate for any business. The same sort of opportunity KEY Investment Partners talks about is also available for retail investors who can identify companies with strong brands and stronger balance sheets that will use today’s crisis to expand even further. The problem is, not everyone who is said to have a strong brand actually does.

An Apple Store for Pot Products

We first looked at marijuana stock MedMen back in February of 2018, questioning how they reached a billion-dollar valuation with just $53 million in funding. A uranium company was involved, and the whole thing looked shady. At the time, they were building what Mashable called “an Apple Store for pot products.” Following the typical reverse-merger route, MedMen became a publicly traded company last year with a $1.6 billion market cap. Around March of last year, CNBC called MedMen the “best-known cannabis retailer in the United States.” In September of last year, we warned on MedMen in our piece titled MedMen Stock Slides Amid Rapid Expansion stating:

You can browse through MedMen’s list of $88.7 million in payable notes and see what sort of terms they’re getting yourself, or you can just pass on this grass in favor of other cannabis multi-state operators where the ex-CFO isn’t complaining in a lawsuit that the CEO called him a “pussy-bitch” and made him share a parking space with his executive assistant.

Since we warned our readers about MedMen, shares of the company have lost nearly -90% of their value. Things have gotten so bad now that the “co-founder and president of marijuana juggernaut MedMen” had to sell his Hollywood mansion. Life comes at you fast:

  • July 2019 – Marijuana magnate Andrew Modlin snags $11 million Hollywood Hills mansion
  • March 2020 – President Andrew Modlin has jettisoned his West Hollywood home to YouTuber Emma Chamberlain for $3.9 million.

One bad apple like MedMen can cripple the performance of an entire ETF.

Conclusion

It’s difficult to compare multi-state operators when each has a completely different exposure to various U.S. states, aside from just ranking them by market cap. Investors need to find the marijuana companies that are best suited to rapidly integrate across states if cannabis ever becomes legal at a federal level. Having strong multi-state brands would be a prerequisite to that. Maybe instead of stock picking, we should look at making diversified investments in cannabis using ETFs.

If ETFs are down since the start of the coronavirus and sales are way up, it only makes sense that the benefits will show up down the road. Now seems as good a time as any to go “long and strong” on the biggest marijuana ETF out there – MJ – using dollar cost averaging to reduce market timing risk. Then again, the music has stopped for all those companies running heavy losses in favor of expansion. With funding drying up, the weak will go bust. For ETFs, those losses may offset any gains made by companies who benefit from the coronavirus sales boom. Again, we reach the same conclusion. Both marijuana stocks and ETFs just seem too risky. We’d rather look for some bargains in good old boring dividend growth investing stocks.

Here at Nanalyze, we hold the lion's share of our investing dollars in a portfolio of 30 dividend growth stocks. Find out which ones in the Quantigence Dividend Growth Investing report freely available to Nanalyze Premium subscribers.

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