Since its legalization for recreational usage in multiple states, marijuana has attracted billions of dollars of capital investment.
The pot stock boom is in full swing, with marijuana companies grabbing the attention of investors around the world. Billions of dollars are flowing into the industry, and investors are being rewarded for jumping on board. Tilray (ticker TLRY), a Canadian cannabis company, has been the face of the boom. The company went public in July of this year at about $23 per share. A few months later, the shares traded above $214 before falling back to around $100 in October. Had you invested $500 in Tilray in July, you would have had about $4,652 by the middle of September (and about $2,170 today).
There is no doubt that the marijuana (both medicinal and recreational) industry is growing. Fortunes are going to be made (and lost) in the coming years. But are marijuana stocks a good investment?
To answer this question, we must first differentiate investing from speculating. Ben Graham, the “Dean of Wall Street” says in The Intelligent Investor: “An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting these requirements are speculative.”
Company assets and earnings determine value to investors, while speculators often gamble on future price fluctuations based on past price movements. In this article, we will focus on the investment merits of marijuana companies.
So, like any stock, the fundamentals of the company must be examined to determine the long-term success of the stock. At its September peak, Tilray was valued at more than $19.6 billion, while its 2017 revenue was only $21 million and the company lost $8 million. Compare this to L Brands Company (owner of Victoria’s Secret and Bath and Body Works) which is valued at about $13.2 billion, with 2017 revenue of $12.6 billion and income of $983 million. Would you rather pay $19 billion for a company with sales of $21 million and negative net income, or pay $13 billion for a company with $12 billion in revenue and just under a billion dollars in income?
This example is not to say that Tilray won’t succeed, but rather to point out that there are many built in assumptions (and rampant speculation) with the stock. Prudent investors have a hard time even considering Tilray due to its expensive price in relation to its earning power and future business prospects.
This isn’t the first time we’ve seen speculation in a new market. Let’s examine three examples.
First, let’s look at cars. The automobile was brand-new in the early 1900s, and there were hundreds of auto manufacturers. Despite the obvious bright outlook of the auto industry, most of these companies failed. By the late 1920s, there were only three large car manufacturers in the U.S. (General Motors, Ford and Chrysler).
Next, let’s look at the internet. In 1999, a company named eToys.com went public. The stock shot up quickly and reached a valuation of $7.7 billion while only having $35 million in revenue and recording a $73 million loss. The valuation of eToys was the norm when it came to internet companies in the late 90s. By 2002, most of these companies had gone bankrupt.
Third, and most recent, we have the Bitcoin craze of 2018. Rampant speculation led Bitcoin to a high of over $19,000 before falling back to the current price around $6,500.
These examples aren’t meant to deter you from the marijuana industry, but rather to challenge investors to exercise prudence and rationality when examining pot stocks. In the above three examples, brand new technologies were introduced to society; cars, the internet and Bitcoin have all changed the world. Despite this, their arrival brought rampant speculation in financial markets and caused many investors to lose their hard-earned savings.
Remaining grounded in the fundamentals of the business will help you determine the merits of investment, and avoiding speculative situations will protect you from euphoric bubbles and their inevitable bursts.