Buy Cannabis Stocks but Not Blindly

December 4, 2022 at 6:19 pm
Exclusive article by Alan Brochstein, CFA
 

You’re reading a copy of this week’s edition of the New Cannabis Ventures weekly newsletter, which we have been publishing since October 2015. The newsletter includes unique insight to help our readers stay ahead of the curve as well as links to the week’s most important news.

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Friends,

Despite cannabis stocks having a very challenging year, this quarter has been quite strong. The New Cannabis Ventures Global Cannabis Stock Index is up 31.4% since 9/30, when it posted an all-time closing low:

 

The index, which closed at a three-month high on Friday, is up a small amount since June 30th now. The strong rally since 9/30 has outpaced the S&P 500 rally of 13.5%, but the modest gain since the end of June leaves it trailing the S&P 500 since then. In 2022, cannabis stocks are down a lot more than the S&P 500’s decline of 14.3%. The Global Cannabis Stock Index is down 55%, and it has declined 84% since the peak close in February 2021.

As we have shared over the past few months, we are optimistic that better returns lie ahead for the cannabis sector. With a powerful rally now underway, we want to warn our readers that investors need to be careful with the securities they select for investment.

We have shared stocks and funds that we don’t like in this newsletter. These include some of the ETFs, which we find highly undiversified, as well as Canopy Growth, which is trying to execute a strategy that doesn’t excite us.

Today, we want to warn our readers to be very careful with low quality cannabis stocks, most of which are not ever covered by us. While we may name names, it’s not our goal to create a list of stocks to avoid. Instead, we are hoping to teach our readers some characteristics of companies that suggest caution.

Avoid Heavily Promoted Stocks

In the almost 10 years of watching the cannabis sector, we have seen a lot of nasty stock promotion, which is egregious outreach to investors paid for by a company or a third-party that suggests buying the stock. Stock promotion doesn’t help in the long-term, but it can, sometimes, cause short-term interest in the stock. Investors should be cautious of stocks that are running up after the company has promoted the stock.

Know the Management Team

Let’s face it: Scammers know that the cannabis industry excites a lot of investors at times. Someone looking to get rich quickly might be tempted to become a cannabis company or a company that services cannabis companies. We saw a company go public on the NASDAQ recently that was launched by a sub-penny stock owner. The CEO is the head of the sub-penny stock too. The sub-penny stock spiked in early 2021 above $0.10 and then to $0.02 this summer around the time of the IPO but now trades below $0.002. There is more to the story that concerns us, but this was a red flag in our view.

Understand the Balance Sheet, Cash Flow and Access to Capital

This year has been tough for cannabis companies, as capital availability has tightened. Perhaps now investors are in tune with this lesson, but historically, they haven’t paid too much attention. Simply, investors need to assess a company’s capital needs. Dilution can really harm investors.

Check the Story

We aren’t trying to call out negatively Agrify today, but we were concerned when the company’s stock was much higher. It is down 99% in 2022 after running up post-IPO in 2021. The company claimed to have a technique for helping cannabis growers become more efficient and productive, which captured the attention of investors. We waited for the company to announce a big customer, but they never did. Instead, the company announced in October 2021, after its stock had peaked, an acquisition of two extraction companies. The move seemed at odds with the focus of the company on growers. Investors should always check the story! For example, there is a Canadian LP that likes to talk about its asset in Texas that could be converted into a THC production facility, but this Texan has never credited the company for this. There is a California-based grower that talks up its ability in the future to export to other states, but we are not counting on this to happen in the near-term. If it sounds too good to be true, then it probably isn’t true!

Conclusion

We are optimistic that the long and deep decline of cannabis stocks could be over, but we don’t think all cannabis stocks are a buy. While today’s newsletter has been about avoiding low quality stocks, we think that investors that buy only the highest quality stocks face risks as well. The biggest are not necessarily the best! We are finding a lot of apparent bargains in a lot of different sub-sectors, but the one sub-sector that stands out right now are the ancillary stocks.


At 420 Investor, we focus on 31 stocks and hold just 12 currently in our model portfolios. We are careful to avoid heavily promoted stocks, we look for management teams that are strong and we pay attention to the financials and are always checking the story, too.