Will Cannabis Stocks Go up in Smoke?

Paul Dykewicz

Will cannabis stocks go up in smoke or let investors find profitable opportunities amid the high valuations of many of the early entrants?

The answer could be a combination of both with many of the companies chasing a global legal marijuana market projected to reach $146.4 billion by the end of 2025, based on a forecast from Grand View Research, Inc., a San Francisco-based market research and consulting firm. The use of marijuana for medicinal purposes to treat patients with cancer, mental disorders, chronic pain and other health problems is expected to boost cannabis revenue growth as legalization expands in the United States.

Roughly 70-75 percent of cannabis trade is illegal in North America, but that number shrinks to just 30 percent in states where marijuana has been legalized, the research firm found. Combined sales of legal and illegal cannabis are estimated at $50 billion and likely to reach $80 billion by 2030, according to Cowen & Co. cannabis analyst Vivien Azer.

Will Cannabis Stocks Climb or Go to Pot?

“Cannabis investments today are much like computer hardware and software investments in the mid-1980s,” said Bob Carlson, who leads the Retirement Watch advisory service.

It is possible that a few of today’s pioneering cannabis companies someday may dominate a large and growing industry but most of the stocks will fail and lose all their investors’ money, Carlson predicted. In addition to the usual problems of a new industry, cannabis investors have to deal with “extra layers” of legal and medical uncertainty, he added.

“At this point, the sector is only for speculators who can afford to lose their investments,” Carlson cautioned. “The best way to approach it if you’re interested is to buy a little of every company you can and hope that one, or two of them, eventually becomes a large company. You can buy the companies directly or through the various funds and ETFs that are forming to specialize in cannabis.”

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Jim Woods, who leads the Successful Investing, Intelligence Report and Bullseye Trader advisory services, recently recommended an exchange-traded fund (ETF) that has been soaring so far this year and letting investors gain exposure in a number of cannabis companies by making just a single investment in ETFMG Alternative Harvest ETF (NYSE:MJ). The ETF offers a pure play on cannabis, but he warned subscribers of his Successful Investing service that the sector tends to be “very volatile.”

As a result, investors who want to own shares of MJ should purchase them with the aggressive portion of their portfolio if they can afford to take the risk, Woods said. To protect the investment from a deep dive, Woods set an exit point 15 percent below the purchase price.

While the S&P has risen about 12 percent so far this year, the gain pales compared with the 46.3 percent jump in MJ, which is the best-performing sector exchange-traded fund (ETF) in the market today.

Chart Courtesy of stockcharts.com

Canada’s move to legalize recreational marijuana use last Oct. 17 gave pot stocks there a big boost, especially since many of the companies engaged in the business are based in the country. Tobacco and beverage companies also have joined in the cannabis craze with Constellation Brands Inc. (NYSE:STZ) and Anheuser-Busch InBev (NYSE:BUD) taking stakes in cannabis growers Canopy Growth Corp. (NYSE:CGC) and Tilray Inc. (NASDAQ:TLRY), respectively.

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Even the iconic Martha Stewart brand has entered the world of cannabis by partnering with CGC to help the company develop and market cannabidiol (CBD) products for people and animals as part of her wellness initiatives. CBD is the non-psychoactive portion of the cannabis plant that does not cause a high but does offer medicinal benefits for various ailments.

Chart Courtesy of stockcharts.com

Woods recently traveled to Medellin, Colombia, to visit the production headquarters and plantation of medical cannabis producer PharmaCielo, Ltd. (TSXV: PCLO). Another investor who took the trip to check out the facilities and the crop was former Congressman Dana Rohrabacher, who once called me for a phone interview just before he took his surfboard and rode waves in the Pacific Ocean.

This time, the one-time lawmaker is looking to ride the cannabis wave sweeping much of North America.

Jim Woods visits the Colombian cannabis fields.

Woods said the firsthand knowledge he acquired on his trip to Colombia was “extremely” helpful, since he learned much about the production, cultivation and extraction methods for cannabis. He also said he appreciates the medical applications of CBD to reduce systemic inflammation, pain, anxiety and depression. CBD also is used to alleviate cancer-related symptoms, to enhance neurological health and aid cardiac-related health, such as lowering blood pressure, Woods added.

From an investment perspective, Woods said he is convinced the market for medical CBD will become huge in the next several years.

The bottom line is that evolving social norms, increasing government approvals in the United States and around the globe and the rising acceptance by the medical community regarding CBD products have made the cannabis/marijuana sector a genuine investment opportunity, Woods said.

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Choosing to buy a particular cannabis company, such as Canopy or Tilray, is really a matter of strategic posture and valuation, said Hilary Kramer, a Wall Street professional who leads the Value Authority, GameChangers, Turbo Trader and Inner Circle advisory services for individual investors. Canopy, Aurora Cannabis Inc. (NYSE:ACB) and Tilray supply 60 percent of the Canadian cannabis market between them. Canopy is the biggest of the three, while Tilray is the smallest and Aurora fits in the middle.

As a commodity business, scale isn’t everything, Kramer said.

“Often it isn’t even something you want to pursue because the cost of expanding production will only result in a supply glut and crashing prices, which hurt you as well as your smaller competitors,” Kramer said. 

Tilray’s share price has been on a downward slide since last September, but the company has been aggressive in lining up partnerships. It also has a lower valuation compared to Canopy and Aurora.

Chart Courtesy of stockcharts.com

Tilray’s share price is 35 times its projected 2019 sales, while Aurora’s price is 39 times its estimated sales and Canopy’s is 80 times its predicted sales, Kramer said.

Chart Courtesy of stockcharts.com

“This factors in anticipated near-term growth, so Tilray is the best bargain of the group and Canopy looks the most mature or even overbought,” Kramer said. “For Canopy to provide the same growth-adjusted value to investors as either of the others, it would need to fall 50 percent.”

In comparison, established companies such as Coca-Cola (NYSE:KO) are trading at 6 times expected 2019 sales, while Apple (NYSE:AAPL) is at 3.5 times and Amazon (NASDAQ:AMZN) is at 3 times their forecasted sales.

“As speculative and wild as Tesla (NASDAQ: TSLA) has been, it’s below 2 times 2019 sales,” Kramer said. “All of these companies are profitable. They’re making money. Big cannabis won’t do that for some time to come.”

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“An investor can simply weigh each of these companies by the numbers, in which case I’d argue to buy the lowest valuation and the highest growth rate, ignoring everything else,” Kramer said. “Or look at where management wants to take each growth operation. Canopy has the obvious alliance with Constellation Brands Inc. to develop cannabis beverages.”

Canopy seems to be taking aim at value-added consumer products in a possible push to become the cannabis industry’s Coca-Cola, Kramer opined. Tilray wants to grow, so every overseas medicinal market matters more to that much smaller rival.

“If you believe in cannabis as medicine, this is the place,” Kramer said. “And Aurora is simply in the middle, trying to scale up to beat Canopy while looking for value-added products that take its raw crop to the next level.”

Kramer said the numbers currently give an edge to Tilray, especially with its price languishing since last fall. She praised its ambition and potential portfolio impact.

“Canopy has picked its partner,” Kramer said. “Aurora doesn’t seem to be in much of a hurry. Tilray is hungry and this is probably where the next big announcement will come from.”

For investors looking to cash in on the cannabis circus, Canada offers three companies that seem to be among the current favorites to survive whatever shakeout occurs. Even smaller companies, such as Tilray, could become takeover targets, especially if their valuations fall further to make a buyout less costly for the acquirer. Either way, investors have a chance to turn a profit and celebrate by smoking a cigar or maybe even something else.

Paul Dykewicz, www.pauldykewicz.com, is an accomplished, award-winning journalist who has written for Dow Jones, the Wall Street Journal, Investor’s Business DailyUSA Today, the Journal of Commerce, Seeking Alpha, GuruFocus and other publications and websites. Paul is the editor of StockInvestor.com and DividendInvestor.com, a writer for both websites and a columnist. He further is the editorial director of Eagle Financial Publications in Washington, D.C., where he edits monthly investment newsletters, time-sensitive trading alerts, free e-letters and other investment reports. Paul previously served as business editor of Baltimore’s Daily Record newspaper. Paul also is the author of an inspirational book, Holy Smokes! Golden Guidance from Notre Dame’s Championship Chaplain,” with a foreword by former national championship-winning football coach Lou Holtz. Follow Paul on Twitter @PaulDykewicz.

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