Cannabis Investing 5: When Moon, Mars and Stars?
Updated: Jul 7, 2022
The pandemic has changed the investment landscape in ways that I could never have imagined. Traditional “old school” value investing based on fundamentals has stepped aside leading to the phenomenal You Only Live Once (YOLO) school of investing in Meme stocks, cryptocurrencies and other sentiment fueled sectors. This has led to some crazy “To the Moon” expectations, which when not met, leads to whining on social media.
The cannabis sector also had crazy expectations and at the time of this blog’s launch (June 2022) the investor sentiment for this sector is at probably an all-time low. “Dead money” is a term you often hear. Sentiment has been on a decline since March of 2021 and this has been worsened with Senator Schumer delaying CAOA from April 20, 2022 to several months later. The industry and investors were eagerly looking forward to some good developments on the 4/20 date, as that was the justification for Schumer and his friends to block the SAFE Banking Act in the senate. This lack of delivery, another in a series of failures to deliver on promises made, could not have come at a worse time. The markets started pulling back soon after with selloffs in Technology and other sectors, and Cryptocurrencies. The already low valuations and share prices of Cannabis stocks only kept falling lower with no support.
From Senator to CEO, to repeatedly overpromise and underdeliver is one of the most effective ways to destroy credibility and goodwill among supporters and shareholders. The only thing worst would be actions that are illegal and/or unethical. Once credibility is lost it becomes difficult for these people in power to regain the trust of those who believed in them and are the true cause of their success.
Given this low sentiment it is important to set expectations right for the stocks covered here, especially in terms of timing of the next bull market and the various price target scenarios presented in this blog. Nobody can predict the timing of the next bull market. But as seen in past bull markets, it will probably happen so fast that stocks could easily double in just a few days, reducing potential gains by half. The bull market could happen in 2022 if we see some progress in legislation (banking/tax reform, uplisting, descheduling, legalization, etc) that leads to reversal in sector sentiment. Or it could happen in a future year. There is incentive for US politicians to get some wins by mid terms (2022) or by the end of Biden’s Presidency (2024), given the strong support for cannabis legalization with US voters.
US Federal Legalization as a driver of sentiment is actually... most illogical.
If you analyze the fundamentals, you see that the strong companies will continue to thrive even without US Federal legalization. More states are legalizing and the market is growing, not just with new markets but also the transfer of market share from illicit to legal markets. The SAFE Banking Act would add tremendous value not just for corporations but also employees and customers, while reducing crime and the deaths of innocent store employees. But with or without such changes, the large companies will benefit from significant barriers to entry from small businesses. Hence, to continue to focus on the fundamentals is the logical thing to do.
One possible scenario to prepare for is that comprehensive US Federal Legalization may not happen during the Biden presidency. This is because success depends on bi-partisan consensus which requires individual ego to step aside for the greater good. Even though legalization would be a great service to the US population and all of humanity, it may not happen anytime soon.
From a cannabis investing perspective the more important change would be legislation like the SAFE Banking Act, that could improve fundamentals across the industry and open the door to more institutional investors. The scenario of allowing the OTC listed MSOs to uplist to Nasdaq/NYSE and institutional investors to invest in these stocks, would be a powerful catalyst for the cannabis sector.
My rationale is to Buy Low Valuation, Sell High Valuation; included as a principle in this blog’s Investment Methodology. Single digit PS valuations (especially below PS ratio of 5) offer a good value proposition for companies growing at high revenue growth rates. The table in the Best Cannabis Stocks page shows PS valuations along with the average Quarter over Quarter (QoQ) Revenue Growth for the decade starting Q1 2020. You see that several of the high ranked stocks have PS valuations in the low single digits, in spite of having 15%+ average QoQ revenue growth for the decade. It is fundamentals and logic defying to see valuations lower and revenue growth higher than other sectors, including Technology and Electric Vehicles (EV). And trends show that the cannabis market will keep growing till 2025 and even beyond. Anyone who invests now and is willing to hold till 2025 will benefit from revenue growth, and also a potential bull market between now and 2025.
That’s where the “old school” value investing mindset plays a role in success. If you cannot hold for the next bull market, this may not be the sector for you to invest in. If you can hold, you get to ride not one but two waves – the revenue growth wave and the bull market valuation wave. The combined effect of these two waves can magnify the potential gains in share price appreciation, making this potentially one of the great investment opportunities of the century. Each stock that I have an investment thesis page for in the STOCKS category has a scenario analysis and price targets modelling the two waves of revenue growth and bull market valuation.
I’d like to present one additional analogy in this series of articles providing an overview of the cannabis sector investment thesis. Current cannabis investors are the nerds who came to the party early. Visualize this conversation between guy nerd and girl nerd:
Guy nerd: Did you see Trulieve’s Q4 results? Amazing, right?
Girl nerd: Absolutely incredible. 300 million plus revenue, second time in a row!
Guy nerd: Correct! And 100 million plus AEIBITDA again. Phenomenal.
Girl nerd: And that interview with Kim Rivers was so inspirational, right?
Guy nerd: Right. So glad to be a shareholder.
Awkward silence follows as both are reminded of the share price stagnating around 52 week lows. They check their phones. Yup, the phenomenal fundamentals still haven’t moved the share price. This is so painful.
Suddenly the music changes and they realize that a whole bunch of new people have joined the party. They are energetic, fun and have brought the dull party to life. Things have gotten upbeat and one of these new entrants has taken over the music and is blasting some catchy salsa tunes. The floor is being taken over by dancers showing of their skills while guy nerd and girl nerd get out of the way and stand by the wall. Girl nerd loosens her pony tail and removes the loose sweater she has been wearing so far. Guy nerd takes one look at her and thinks, damn didn’t realize she was so hot. One of the cool kids walks over to girl nerd and asks her to dance. She politely declines. She then turns to guy nerd.
Girl nerd: Do you salsa?
Guy nerd: Sure do. Been taking lessons for two years. Let’s dance.
For both, the party just got started.
Any cannabis investor investing using fundamentals is a nerd, myself included. I don’t use the term nerd in a derogatory way. I am a proud nerd, and love all nerds. We look at fundamentals, numbers and data. But the market cares not just about fundamentals, but also about hype and institutional participation. The folks who brought the party to life are the institutional investors. There can be no sustained share price rally without them. The real fun will happen only when they enter the party. Until then, you might get bored and frustrated. You might even choose to exit the party early out of frustration. Nobody knows when party (bull market) will happen. But you will recognize it easily when institutions start accumulating.
The point to note is that institutional investors are not just cool, they are nerds themselves. They like numbers, data and fundamentals, and many have analysts whose job is to produce research reports that are used to advise clients and the investment community. In addition they have resources and connections that give them the power to influence the markets. They are the experts invited to share their opinions in mainstream media.
I envision a day with new Vangard and iShares cannabis ETFs. The AdvisorShares MSOS, ETFMG MJ and AdvisorShares YOLO ETFs analyzed in this blog, combined had less than US$2 Billion in Assets Under Management (AUM), at the time of this blog’s launch. Imagine the impact of the funds from institutions with trillions in combined AUM being able to finally invest in the sector. My multiple pages in the ANALYSIS category have analyses on valuations (PS), revenue growth, AEIBITDA, etc. I am not a professional investor and I did this part time with a full-time job and family commitments. Imagine the amount of due diligence, analysis and reports published when these institutions, with armies of analysts far more qualified than me, analyze the valuations and growth of this sector. I could be wrong, but I see a good probability of this being one of the great investment opportunities of the century, similar to what we have seen with the Electric Vehicles (EV) sector and cryptocurrencies, before the selloff of 2022. If you can wait patiently for the party to begin, you might just have a really fun (and hopefully profitable) ride.
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When can we expect the next cannabis bull market?
This is a difficult question to answer. We saw a bull market that peaked in February 2021 soon after Biden became President. But we saw that crash when there was no execution to follow the election promises. The next bull market will likely happen during (or before) some meaningful legislation progress happens in the US. But for the bull market to be sustainable, the US MSOs need to uplist to Nasdaq or NYSE, and institutional investors need to be able to invest.
Depending on the timing of implementation of uplisting and institutions joining the party, we might see a scenario where the bull market will favor the Nasdaq listed senators first, while the gladiators miss out. Such a scenario would see senators like Tilray, Canopy Growth, WM Technology and High Tide rise to disproportionately higher valuations, at which point they can raise large amount of funds through equity offerings. These funds could be used to buy out OTC listed gladiators at low valuations (using creative techniques to do so legally). This would see the Canadian companies become winners and major players in the global Cannabis industry. The irony of this scenario is that the US politicians, with their delays and political agendas, could end up being the cause of a transfer of strength from US to Canadian companies, who are fortunate to be on Nasdaq/NYSE and hence benefit from institutional fund flow and trading volumes. To avoid this scenario, accelerating the uplisting of US MSOs would be a patriotic act in favor of US Cannabis companies. But based on the lack of meaningful progress since Biden became President, there is a probability of delayed uplisting scenario happening, benefitting Canadian companies. Only time will tell. But it would be strategic to invest in a balance of good quality stocks listed across the exchanges, some on the OTC and some on the Nasdaq/NYSE exchanges.
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Disclosure: I (username Adastra) am an investor not a trader. I am bullish on the Cannabis sector as a long-term investment (2025 and beyond), provided stocks/ETFs are carefully picked based on data-driven due diligence. Of the 15 stocks covered in the Best Cannabis Stocks analysis, I own only High Tide, which I am holding as a long-term investment. But my analysis indicates (without any guarantees) that there is a potential for impressive gains in investing in the stocks best ranked in the analysis, including WM Technology, Trulieve, Curaleaf and any other stocks that will have a dedicated page. I reserve the right to buy or sell at any time any of the stocks mentioned in this blog. I do not short stocks and never will short any stock in a company that makes the world a better place. I do not have insider knowledge of any company covered in this blog. All data used for analysis is from public sources. I have received (as of last update date of this page) ZERO funding for this blog from any of the companies featured in this blog.