February 11, 2021
I wrote the article below in mid-December 2019, but since pot stocks are the fad at the moment, I thought I would run it again with a refresher. The article is unedited, but first the update as to how the ETF's I mentioned towards the end of that article, plus one additional ETF (POTX), have performed since then:
The conclusion is that you missed nothing by staying out in 2020. However, as you are reading constantly at the moment, cannabis stocks / ETFs are suddenly red hot, attributed mainly to the Reddit crowd and retail. Now FOMO will be a driver almost certainly. Nonetheless, the fact is that this industry will grow and it is probably worth having a stake in it, although investors in cannabis should be prepared for regulatory interference and a lot of bumps along the way. Still yet, the future is bright, although given the hype, it might be worth letting prices settle a bit before jumping in. Recent history suggests that as soon as cannabis moves off the front page of social media sites, the stocks and ETFs will revert to levels more in line with their future potential.
As far as the references to Motley Fool (which I mention in this article), I don't recall hearing much else about their "new" newsletter (at the time) "Marijuana Masters" after I mentioned it originally in the article below. Perhaps this is unfair, but I would reckon interest faded fast at MF but that the resurgence in interest in cannabis stocks means that they will be out pumping the sector again in no time, at least until prices settle which they eventually will.
I hope you enjoy the article below given the sudden interest in cannabis, perhaps slightly dated, but in many respects still appropriate today. (One more thing to note is that now more US states have approved cannabis, and the map in the article below has not been updated.)
December 18, 2019 (original and unedtted)
Let me begin by saying that this post is not about the morality of the legalisation of marijuana but rather is about the attractiveness of the sector from the perspective of an investor. I decided to write about marijuana because I watched a 30 minute presentation this morning entitled “Cannabis 2020: Turning Green into Gold” by The Motley Fool. I should disclose upfront that I am a basic member (“Stock Advisor”) of The Motley Fool, and I have found over the years that they have some excellent ideas and recommendations. I am getting the disclaimer out of the way upfront because – as an aside - I am finding The Motley Fool increasingly annoying in pushing subscriptions for new newsletters to its basic members, this one regarding cannabis included. But let me come back to this in the last paragraph of this post.
As an investor, I have avoided the marijuana sector so far, even though the FOMO (“Fear Of Missing Out”) at the onset was strong. The brief history of marijuana stocks is not good at all, as the valuation of the listed companies was wildly inflated until earlier this year because investors’ sentiment seemed to be along the lines of “a rising tide will lift all ships”, and the tide in this case was the strong sector growth dynamics. But this was not to be, at least not yet, as nearly every individual stock and marijuana ETF has been a loser so far in 2019 (while the S&P 500 has soared nearly 25%). This doesn’t mean that the day for marijuana stocks will not come, and perhaps this will be soon as the medicinal uses are better understood and the applications become broader. Also, people are becoming more open-minded with respect to the legalisation of recreational pot, as this chart from Gallup illustrates.
Now if or when marijuana ever becomes legal is anyone’s guess. However, there should be more investor opportunity as the bubble in marijuana stocks and ETFs deflates, and the valuations come more in line with the issues that are facing this exciting industry.
Let’s start with the basics. As you are probably aware, Canada has approved recreational marijuana at the federal level, but the United States federal government has not. Even so, the US federal government has more or less “looked the other way” while states, one after another, have legalised medicinal or recreational marijuana. Here’s where we stand today as far as the legalisation of marijuana for medicinal or recreational use by state:
In comparison, the Canadian marijuana industry got off to a bit of a rocky start even though pot was legalised at the federal level, which shows that legalising cannabis did not necessarily lead to immediate success for Canadian marijuana companies. Let’s face it - this is a tough business that will inevitably get more and more competitive, too, so each company’s dynamics have to be examined carefully. An investor simply cannot forget to drill down deep and look at the individual company metrics in every case, whether the company is Canadian or is based in one of the US states where marijuana – medicinal, recreational or both – is legal.
In fact, for those listed marijuana companies and for the handful of ETF’s focused on marijuana, the story so far has been very poor for investors that invested early on. Before looking at the performance of several marijuana stocks and ETFs, let’s step back first and look a bit closer at the investment thesis for marijuana.
The size of the US marijuana market in 2018 was $13.8 bln according to Grand View Research, and is expected to grow on average of 23.9% per annum through at least 2025. According to the same report, marijuana for medicinal uses accounted for $7.2 bln (52%) of marijuana sales in 2018, which is arguably the largest potential driver of future growth. Cannabis is used for “the treatment of chronic diseases such as pain, cancer and mental disorders.” Other reports on the industry suggest that the US marijuana market could be a $50 bln to $90 bln industry by 2025. This is a very broad range, so it is clear that analysts have wildly different perspectives of the potential industry growth. Also, as you are thinking about the investment thesis for the industry, you need to keep in mind that marijuana remains illegal at the federal level in the US. The illegality at the federal level is a cloud over the industry, and as a result, banks won’t deal with these small, innovative companies for fear of falling afoul of federal money laundering provisions. This does not make it easy for US marijuana companies.
So what are the other risks of this industry that underlie an investment thesis?
1. Industry growth rates are positive, not a difficult call. But as I mentioned earlier, the expected growth varies dramatically depending on who you speak to, and it is hard to say which analyst will be right until we look again 5-6 years from now. 2. The U.S. government might eventually get on board with the states and legalise pot. In fact, #POTUS has gone quiet on this, most likely a reflection of the slowly growing momentum in favour of legalisation of marijuana in Congress. Of course, if and when this might occur is anyone’s guess, but it would undoubtedly remove a dark cloud hanging over the industry today. 3. Proof of effectiveness of marijuana as a medicinal aid is acknowledged in some cases but remains speculative in others. Only time and additional research will determine just how effective marijuana is for pain relief, etc. 4. The stigma of recreational pot is slowly wearing off. Let me digress a moment. It is hard to believe in fact that the Drug Enforcement Agency has marijuana as a schedule 1 substance – meaning “the most likely to be abused and with no medicinal benefits” - alongside LSD and heroin and at a higher (i.e. more dangerous) level than the likes of cocaine and crystal meth. And in case you are wondering, as I was, as to why alcohol and tobacco aren’t included on the DEA list of dangerous substances, it is apparently because they have a long-standing special exception in the Controlled Substances Act. Many think both alcohol and tobacco would otherwise be schedule 1 substances. Although slightly dated, this article from vox.com does a really good job explaining how the DEA schedules – or tiers – drugs.
If you are an investor that is intrigued by this sector, and assuming that you are willing to “roll up your sleeves” and do work on individual names, then here are the top 25 individual cannabis stocks by market cap: https://www.cannabismarketcap.io. Now I haven’t had the time (or interest) yet to look at these names in detail, although the ones most discussed are the likes of Canopy Growth (NYSE: CGC), Aurora Cannabis (NYSE: ACB), Tilray Inc (NASDAQ: TLRY), Cronos Group (NASDQQ: CRON) and Canopy Growth Corp (NASDAQ: WEED). So how have these stocks performed? In a nutshell, very poorly, especially in the context of the S&P 500 returning around 25% YtD.
So if for example you would have bought any of these six names on January 1 of this year, you would have lost 30%-50% of your investment just this year with the exception of Curaleaf Holdings (now $5.53/share, flat since beginning of year but down 34% since its listing in October 2018 and down more than 50% since its high of $11.23/share only six months ago in May 2019), and Arena Pharmaceuticals, up 15% YtD. I haven’t spent time researching these names to understand their movements, other than to say that the stocks generally seemed very overvalued before correcting. How much further is left to go is not something I can intelligently opine on.
Now rather than individual stocks, let’s assume that you like the investment thesis of the industry but don’t know which stock to buy (the camp I would fall into). So why not, in this case, invest in a marijuana ETF? This article etf.com. covers the marijuana ETFs very well, and is worth a read if this is your interest. Some of the better known ETFs include:
Cambria Cannabis ETF (TOKE): started July 2019: down 24.2% since inception
ETFMG Alternative Harvest (MJ): largest in terms of AUM, started 2015: down 28.05% YtD, and down 8.52% (NAV) for last three years
Advisor Shares Pure Cannabis (YOLO): started April 2019, down 33.6% last three months
The Cannabis ETF (NYSE: THCX): down 34.4% last three months
But the fact is that the marijuana ETFs, similar to the individual marijuana names, have not performed well recently, as this chart illustrates.
With marijuana stocks and ETFs being battered this year, there might be an opportunity. It is far from straight-forward in my opinion, and picking the winners and losers will be very difficult. Nevertheless, if you want a taste of this business early on, maybe now is the time to close your eyes and jump in. I think it will be an appreciating sector with many winners, but there is a question around timing, and the industry is not without its sector and individual company risks. So tread carefully!
Now let me close by coming back to The Motley Fool. As I was listening to their presentation on the marijuana sector this morning, my wife – who was listening in - said “why are you listening to this infomercial”? She is right describing the presentation this way, because it concluded with an offer to subscribe to yet another MF newsletter known appropriately - given the subject at hand - as “Marijuana Masters.” This isn’t for me, not because I am not interested in this market, but because I am not interested in paying for insights into a market that is niche on a good day and for which there is plenty of third-party research and a wide array of opinions. So if The Motley Fool wants to recommend a marijuana stock, then do it under the "Stock Advisor" moniker – a special report is only a sales gimmick, and it sours me on the overall service. This is just my two cents…..