Cannabis Investing 6: The Forest and The Trees
Updated: Jul 7, 2022
The woods are lovely, dark and deep,
But I have promises to keep,
And miles to go before I sleep,
And miles to go before I sleep.
- Robert Frost
This last article to wrap up the overview of the cannabis investment thesis highlights the need to look at the big picture, and to not miss the forest for the trees. If you look at the history of the alcohol industry post prohibition (1933), you will see that the growth was not over years but over several decades. As mentioned in my Cannabis Investing 1: Investment Opportunity of the Century? writeup, just 5 alcoholic beverage companies that I listed had a combined market cap of well over US$300 Billion. In comparison, the 15 cannabis companies shortlisted (for high quarterly revenues) and analyzed in the Best Cannabis Stocks analysis, had a combined market cap (at the time of this blog’s launch) less than 10% of just these 5 alcoholic beverage companies.
Cannabis is an original plant medicine with healing powers known to the human species for several millennia. These healing properties of the miracle plant are the root cause of the growing acceptance and consumption of Cannabis. The rise in physical and mental stress and suffering in the human species has highlighted the need for alternatives to alcohol, tobacco, opioids, anti-depressants and other means by which humans cope with stress. The reality, that we often forget, is that it is the humans that need the miracle plant. As human intelligence and consciousness rises, the ignorance and stigma of cannabis will decline.
The trends show an increase in legal cannabis consumption and a decrease in illicit cannabis consumption in legal markets. This trend will continue as more states (within the US) and countries (like Germany) legalize. In addition to recreational consumption, cannabis is being consumed for medicinal purposes and is improving the physical, mental and spiritual wellness of humans lucky enough to have access to this original plant medicine. Research continues to discover uses for this plant and more cures are being derived from it for a variety of ailments. For smokers it has provided an alternative to toxic tobacco. Edibles, oils and other alternatives are growing in popularity amongst consumers. And the biggest disruptor, cannabis infused beverages, is in the early stages but will likely gain in consumption as a better alternative to alcohol.
The trends indicate that cannabis can be for the twenty-first century what alcohol was for the twentieth century. Investors are still early in the sector and if they invest in fundamentally strong companies, they have a good probability of having picked some of the future leaders of this new industry.
The ANALYSIS category of this blog has several pages with detailed numbers and narratives on stock valuations, institutional (ETF) ownership, revenue growth, AEIBITDA, etc. We are now at a point where valuations seem low and the sector is looking like an investment opportunity with strong potential for long term value investors. I’m referring to the old school investors who actually invest based on fundamentals as opposed to memes.
Some quotes from the most famous value investor:
“For some reason people take their cues from price action rather than from values. Price is what you pay. Value is what you get.”
“The critical investment factor is determining the intrinsic value of a business and paying a fair or bargain price.”
“Market prices for stocks fluctuate at great amplitudes around intrinsic value but, over the long term, intrinsic value is virtually always reflected at some point in market price.”
- Warren Buffett
Just as past success does not guarantee future success, past failure does not guarantee future failure. The best investment approach I can think of is for investors to focus on the numbers, data and fundamentals. During a prolonged bear market, valuations tend to get fundamentals and logic defyingly low, while investors grow excessively frustrated and pessimistic. During a bull market, valuations tend to get fundamentals and logic defyingly high, while investors grow excessively irrational and optimistic. A time tested approach is to buy when valuations are excessively low, and hold till valuations get excessively high.
There are several valuation metrics that can be used for valuing companies. My preferred metric for valuing companies in a growth sector is the PS Ratio, as revenue is very important during the growth phase. At some point, earnings become more important IMO than revenue, and the P/E Ratio will make more sense. For Cannabis right now, I have selected the PS Ratio as the metric to value and compare companies in the sector. That said, companies that are making high losses and are diluting shareholders to maintain operations need to be identified and avoided.
As you read through this blog it will be evident to any experienced investor that my focus is on Fundamental Analysis as opposed to Technical Analysis, the former being valuable for investors while the latter often used by traders. I don’t care much for Technical Analysis, while I do acknowledge that when a sizable number of traders use it, it can become a self-fulfilling prophesy.
As an investor, you can make investment decisions based on an analysis of the fundamentals, data and other metrics available. But success is often a combination of fundamentals, hype and events out of the control of any investor. The analysis can be more accurate by quantifying the factors that impact hype, and by doing due diligence on intangibles like the character of the company’s management. But these still have limitations and do not guarantee success. Essentially the analysis is a way to increase the probability of success.
One of the main factors which impact the success or failure of any cannabis investment is the duration of the bear market and future timing of the bull market. Setting any timelines for a bull market is impossible because several factors are at play, as explained in the previous article, Cannabis Investing 5: When Moon, Mars and Stars?
But based on previous bull markets, there is a good probability that the bull market will be around the time of (or preceding) some form of cannabis friendly US legislation. Many investors think of legalization in terms of comprehensive reform with Senator Schumer’s Cannabis Administration and Opportunity Act (CAOA). This would be a best case scenario but one that I would assign a low probability to because it lacks bipartisan support.
The higher probability event would be the SAFE Banking Act, or Secure and Fair Enforcement (SAFE) Act, introduced by U.S. Representative Ed Perlmutter. SAFE Banking would allow banks and credit unions to provide financial services to marijuana businesses that currently operate on cash, and have suffered from robberies and tragic deaths of employees. The final form of the act is unknown but there is a probability of it passing in 2022 before the mid term elections, and it might give the industry two things that could trigger a bull market: tax reform and the uplisting of US cannabis companies onto Nasdaq/NYSE. The latter is the change to look out for, as that would allow more institutional investors to invest and promote the industry, and bring about significant funds flowing into the sector.
Again, timelines are impossible to predict. But my investment thesis would be to invest during the bear market at low valuations, and to hold patiently till the eventual bull market, which could come in months or could take several years. As long as you invest based on fundamentals, you should have a good probability of strong gains, with the probability of success increasing the longer your time horizon is. This is an important point to consider as it will help set realistic expectations and reduce unnecessary stress and frustration.
This Blog has a few STOCKS with an investment thesis, including a revenue growth tracking and forecasting table, and a charts that do scenario analysis for multiple scenarios based on revenue and potential bull/bear market valuations. These charts have scenarios built out to 2025, by which year the annual Cannabis revenues in the just the US could be around US$50 Billion. By that time we might also have countries like Germany and others around the world legalizing cannabis. And we might see additional growth in Canada with market share moving from the illicit cannabis market, alcohol and tobacco to the legal cannabis market. All these trends should be beneficial for the established US and Canadian companies that execute effectively to grow their revenues. While it is probable that we see some form of cannabis friendly legislation pass in the US, leading to a bull market by 2025, investors should be prepared for the scenario that this might not happen by that year. This sounds pessimistic, but is a scenario to be aware of given that any legislation passing is determined by the actions and decisions of politicians.
But cannabis friendly legislation has a high probability of passing eventually. At the minimum, legislation like the SAFE Banking Act would have to pass if there are enough US Senators with empathy and the humanity to care about the greater good of the citizens. Shop owners, especially small businesses, are suffering from the robberies, and workers are literally getting killed on the job. This innocent blood stains the hands of those who voted No for the SAFE Banking Act and for those who continue to vote No till it eventually passes. The ironic part is that SAFE Banking helps small businesses, who are more vulnerable to crime when forced to operate using cash. This means that SAFE Banking is actually a social equity policy, a point missed by those who don’t see the big picture.
Politicians across the world need to focus on the big picture, and should not miss the forest for the trees. The forest should be to increase the size of the legal cannabis market, while decreasing the size of the illicit market which avoids paying taxes while simultaneously jeopardizing public health without regulations in the products sold. Legislation should be passed to help the legal cannabis industry thrive, with business friendly regulations and taxes. When that happens, businesses will be able to operate safely, and good quality products (without toxins) will be available for consumers at prices that can compete with the illicit market. The safety of the citizens, both customer and employee, should be the top priority and highest duty of the politicians.
Policy makers should also learn from the errors made by other countries, which constrained the legal cannabis market’s ability to compete with the illicit market. In Canada, restrictions on vertical integration between producers and retailers was a factor that made it harder for companies to control costs (with better margins) and compete with the illicit market.
Fortunately, the US allows seed-to-sale vertical integration, which helps the Multi State Operators (MSOs) have better margins. Any future restrictions on vertical integration would be a mistake that US policy makers will hopefully avoid, though I have read that this is something some policy makers are considering. Another policy error to watch out for in the US would be restrictions on inter-state commerce. As with other agricultural products, Cannabis should be grown where conditions are best suited for it (like the Emerald Triangle in Northern California).
Restrictions on white label products for retailers was another policy error made in provinces like Ontario. Fortunately, this error is being reversed and retailers will get to launch white label products effective June 30, 2022. This will allow retailers to have better margins through vertical integration and compete more effectively with the illicit market.
Other restrictions seen in Canada, such as the 10mg limit on edibles and number of beverages sold, should also be reversed and avoided. In parallel, law enforcement needs to shut down illicit producers, retailers and websites to destroy the illicit market, as was done to the bootleggers post alcohol prohibition.
Policies should be passed to help the legal cannabis industry compete with the illicit market. This can be done with business-friendly regulations and taxes. These taxes are not just a tax on the companies, but a tax on the consumers and citizens. Business friendly policies will help the legal industry operate more efficiently and produce/sell products that are safe to consume (without toxins found in illicit products) and affordable to consumers already suffering from high inflation.
Now that we have an overview of the cannabis investment thesis, we can proceed to an analysis of the cannabis sector in the pages in the ANALYSIS category. We can then analyze individual stocks and a data-driven cannabis portfolio in the pages in the STOCKS category.
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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.