Pot stocks had markets on a high as marijuana legalization neared at the end of 2018, but like all growth stocks, they came with warning labels.
Unless you were one of the lucky few that bought in to this space before the hype, you should be keeping some basic investing principles in mind to ensure your investment doesn’t go up in smoke.
Valuation
As recreational marijuana neared legalization on Oct. 17, 2018, cannabis stocks were at “peak hype,” according to Allan Gregory, a Queen’s University economics professor who follows cannabis stocks closely.
That meant many retail investors were betting on this growth industry without really understanding its worth, or having hard (or standard) numbers to base their assessment of companies’ value on. Canadian securities regulators also expressed concern about the way many cannabis companies chose to disclose key information, such as possible risks from U.S. operations, where pot wasn’t legal in every state.
“We have the notion that stocks are supposed to represent present value and future income flows … but of course in a growing stock or growing product, like cannabis, we just don’t know what that is,” said Gregory.
While it’s possible these companies will eventually generate the revenues that they are hoping to, until they do, some people are going on hope and speculation, he added.
“These people who invested money in this and got this return have been willing to assume the risk,” Gregory said. “Most of us are careful investors. These are not blue chip stocks – these come with warning labels.”
To Thomas George, president of The Grizzle, a cannabis-focused investment analysis firm, a key measure to look at when examining new industries is execution.
“Certain companies will be in a better position to execute than others, and that really comes down to the quality of management,” he said.
“That’s something (worth) looking at: the experience of management, what they’ve done, what they’ve said they’ve done and what they’ve actually achieved. Those are just classic yardsticks for establishing good businesses.”
While he finds the speculative aspect of the cannabis industry “troubling,” George said he sees huge potential for growth as established beverage and food companies look to partner up with cannabis firms to develop edible products and drinks.
“It’s a classic set up where there are a lot of companies striving to be that ‘it’ player in an industry that will no doubt, when we look at it 10-20 years from now, we’ll say, ‘that was a massive opportunity,’” he said.
Regulation and Competition
When looking at any new sector, it’s also important to take a long view and try to understand where the industry may end up once it has been established.
If the real money is in edibles, will legislation catch up quickly enough to prevent lagging profits? Will producers be able to distribute their products freely, or will they face regulatory obstacles at the municipal level? Will provincial authorities look to regulate pot sales, and take a big enough cut to dampen company revenues?
Pot plants are also fairly easy to grow, which could lead to steep competition, said Gregory.
“It’s pretty hard to stop entry into the market, so the profits are going to be hard to keep high if everyone is coming in and undercutting your market,” he said.
Risk Tolerance
One big difference when trying to assess the value of cannabis stocks when compared with other hype-fuelled new fields such as bitcoin is that marijuana is a tangible product.
“Where it ends up, bitcoin is a bit more unknown than marijuana because (for marijuana) … we’ll be able to measure value of sales, costs subtracted, to get profits,” said Gregory.
“The public companies will have to disclose, there’s going to be light shed on this industry. Even in Dotcom we didn’t know at times what the product was.”
Investors wishing to play it safe could simply wait it out, since the market will eventually mature.
But no matter how far you dig into any one company or the sector overall, like most investments, one of the key factors you’ll need to consider is your own risk tolerance.
“Fear of missing out is never a good mental strategy to get into any investment,” said George, who suggests looking at where this industry is at now, where it can go, and your risk-reward between here and there.
“It’s always a risk-reward scenario, and that really depends on each individual investor’s risk tolerance.”
