1) The industry is filled with untrustworthy and unprepared management teams
Any emerging industry has its share of shadowy characters and unfortunately the marijuana industry is no different.
Investor interest in the sector is so high and so much money is looking to participate in a growing industry, that any marijuana company, no matter how flimsy the business model, can raise millions.
People with track records of business failure or dubious ethical backgrounds are easily raising the money needed to run a publicly traded company.
Many of these management teams won’t have the correct strategy for making money in a legal marijuana market, or will siphon off funds meant for the company into their own pockets as the stock price sinks to zero.
Waiting to invest in marijuana stocks until bad actors have either been arrested or their companies have gone bankrupt will help you avoid making a losing investment in a crooked management team.
Read our Marijuana Management report for more on this»
2) Marijuana stock prices are way too high
Even the best company can lose you money if you pay too much for the stock.
Unchecked investor optimism about the marijuana business has driven the stocks to levels that are unchecked from the likely reality the market will find itself in 12 months from now.
The largest LP in the space, Canopy Growth, trades for 30 times the cashflow it’s expected to generate 3 years from now. The stock market as a whole trades for only 10 times expected cashflow 1 year from now.
If you wait until investors have a better understanding of the true profitability of marijuana, which Grizzle thinks is lower than current expectations, the stock prices will adjust lower, allowing you to buy in at a cheaper price and increase your chances of making money.
Read our Bay Street Gone Wild report for more»
3) Canada is heading for a huge oversupply of legal marijuana
Summing up greenhouse plans from only the top 13 largest licensed producers, Canada will be producing 2 times more supply than its citizens can consume.
When there’s too much of a commodity, the price falls to provide an incentive for people to consume more of it. Lower prices mean less revenue and cashflow for licensed producers and a much lower stock price (down 30% or more).
Grizzle recommends waiting until the oversupply has washed through the industry and stocks have sold off or disappeared altogether before buying in.
Read our Up in Smoke report for a detailed analysis of marijuana oversupply»
Marijuana Supply vs Demand
Source: Grizzle Estimates, Company Data
4) The investor base is fickle and won’t stick around if times get tough
Because the marijuana industry is so new and the drug won’t be legal until October, large sophisticated investors have been wary of buying marijuana stocks.
Most marijuana investors are excited about the potential of the industry, but have limited knowledge about the economics of growing marijuana and how to value the stocks.
When there’s weakness in the stock prices, retail investors lack the conviction to hold their positions for the long-term and often will sell into stock price weakness, making the decline worse.
If you wait to buy marijuana stocks after legalization is in force, more institutional investors will likely own those same stocks, providing a stable source of demand.
Institutional investors invest in stocks for the long-term and know the companies they invest in well. This knowledge gives them conviction to hold their shares or even buy more in the face of stock price weakness.
5) International marijuana laws are changing slower than the market expects
Canada is leading the way on marijuana regulation and is likely providing a roadmap for other countries to follow as they loosen their own marijuana prohibition.
The problem with the recent legislative victories in Canada is that unrealistic expectations are now being set for how quickly other countries will decriminalize the use of the drug. Investors forget it took Canada 11 years to reach legalization.
Germany as an example took 9 months to analyze applications for a cultivation license and then reset the entire application process at the last minute because of a grower lawsuit.
A lack of international demand will be bad for the bottom lines of Canadian producers. Better to wait until investor expectations cool off before buying into the stocks.
6) We don’t yet know how much the government will pay producers for their supply
Bullish investors think retail prices will be set at $10 per gram, a nice round number, while others think $7 or $7.50 per gram is the magic number because it’s close to what medical marijuana costs today.
The stocks are not pricing in the news that’s leaking out from the provinces that they’re negotiating to pay licensed producers only $4.50 per gram or less for their supply.
If wholesale prices end up being this low, cashflow and revenue will disappoint investor estimates, dragging down stock prices.
Waiting until after provinces release the actual price they’re willing to pay before buying the stocks will help you avoid a sell-off that happens because of the news.
7) Edibles won’t be legal until 2019, putting legal producers at a disadvantage
Edibles are wildly popular in legal US states, making up almost half of all money spent on marijuana.
For an entire year after legalization, legal retail stores in Canada will only be able to stock their shelves with dry marijuana flower and oils, while edibles and infused products will remain prohibited.
This distinction provides a significant advantage to a black market that can offer a much wider selection of products to its customer base than the legal market.
If the black market holds on to many of its clients in the first year, legal sales will disappoint the market, driving down stock prices.
As an investor, waiting to buy the stocks once edibles can be sold legally will help you avoid stock price weakness from the industry’s initial failure to displace the black market.
8) Licensed Producers are still issuing piles of new stock, diluting the ownership of current stockholders
In the last 6 months alone, the marijuana complex has raised over $2 billion from capital markets through stock and bond offerings.
On top of capital raising, the largest companies have been on buying sprees and are paying for many of these deals with their own stock.
All this activity is leading to piles of new stock being issued, which is diluting current shareholders. The more shares outstanding means each share is entitled to less of the earnings of the business and should be worth less.
Waiting to buy into marijuana stocks until they’re done fundraising and consolidating will allow investors to avoid the negative price action from share issuance, while benefiting from the growth in revenue and earnings as the market matures.
9) Millions of shares under investor lockups will expire in the next 12 months, putting pressure on stock prices
With all the capital market activity (Initial Public Offerings and follow on stock offerings) among the marijuana stocks in early 2018, there are many insiders who have committed to holding their shares for a predefined period.
These insiders own significant percentages of the outstanding share count and could put pressure on stock prices as they sell some of their holdings to lock in gains after the lockup expires, but before the oversupply appears in late 2019.
The wave of lockup expirations will pass by this time next year, so waiting to buy will be a way to avoid stock market weakness from large scale insider selling.
10) Demand is still a huge question mark
Legal demand estimates are relatively well defined within a range of 650,000 kg to 850,000 kg a year.
The big question mark is if in the early days of legalization there will be lines around the block to buy legal weed or will the streets be empty as buyers stick with their local black market dealer.
The industry is betting hard on an acute oversupply, and if the government in tandem with the producers structure the legal market incorrectly, the black market could hold on to many more paying customers than the stock market expects.
Waiting for a few months of data to make sure the black market is slowly fading will allow you to buy marijuana stocks with confidence, knowing growth in customers and profitability are right around the corner.
About Author
The opinions provided in this article are those of the author and do not constitute investment advice. Readers should assume that the author and/or employees of Grizzle hold positions in the company or companies mentioned in the article. For more information, please see our Content Disclaimer.