Is Cannabis a Good Investment Right Now?
Today, many people are wondering if they should be investing in cannabis related companies. Although it is still illegal as of late 2019 to produce or use marijuana at the federal level, over half the states in the U.S. have approved medical marijuana, and eight states, including trendsetter California, have made recreational cannabis legal.
Given the wave of legalization in both the US and Canada, the national news media are full of stories about the growth of the cannabis, hemp, marijuana and CBD oil markets. In both the US and Canada, there are numerous companies and entrepreneurs creating companies to position themselves to address these markets.
Should you invest in cannabis? Is it a good money making opportunity or a risk better worth avoiding? Let’s take a look.
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A History of Investment Versus Speculation
Some people buy stocks because they believe they are good, long-term investments, and that they’ll make money as these companies generate profits and create value for their shareholders.
Others buy for more speculative purposes to make a trade in the short-term: a hot tip or market momentum coupled with the desire for a quick profit motivates them.
Benjamin Graham, known as the “Father of value investing” offered the following observation of the distinction:
“An investment operation is one which, on thorough analysis, promises safety of principal and a satisfactory return. Operations not meeting these requirements are speculative.”
So is investing in Cannabis an investment or a speculation?
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Speculative Bubbles and The Great Dutch Tulip Mania
In some cases, extreme speculation takes over in certain markets. This can be particularly true in markets early in their development that are subject to many competitors, shifting dynamics and a high degree of experimentation needed to figure out which business models and products will survive and thrive. Examples of early stage speculative markets include the British Railway Mania of the 1840s, the Internet bubble involving the so-called “dot.com” companies, in the late 1990s, and, most recently, the Bitcoin mini boom-and-bust of 2017-2018.
Sometimes, speculative bubbles occur even in assets that make little sense. For example, in the early 1600s, one of the first recorded speculative bubbles occurred in Holland focusing on, of all things, tulips bulbs. It was one of the greatest asset bubbles of all time. By 1634 there was a literal mania for tulip bulbs. Peak prices topped out at a level high enough to buy a mansion in Amsterdam. People were buying using credit and leverage. By 1637, the bubble had burst. Prices crashed. Speculators were ruined.
The Developing Cannabis Market in the U.S and Canada
Years ago, when penalties were stiff for producing and using marijuana, the only markets for cannabis were illegal markets.
With the recent deregulation of cannabis availability, legal marijuana sales have skyrocketed, in part fuelled by the development of medical marijuana. In California, sales of legal marijuana are on track to exceed $3.1 billion in 2019. By some estimates, the cannabis market in the US may reach $35 billion by 2020. By almost any measure, Cannabis is a rapidly growing market.
Not all cannabis is psychoactive. Hemp has been and still is commercially produced in the US. One of the main organic products derived from hemp is Cannabidiol, also known as CBD, which has seen skyrocketing sales fueled by great claims for its health benefits. The CBD market is on pace for over $800 million in sales in the US alone in 2019 and projected to grow to over $1.8 billion by 2022.
In 2018, Canada legalized marijuana nationwide for adult use. A number of private and public-traded Cannabis-related firms are now based in Canada. By late 2017, close to 80 legal marijuana growing firms operated in Canada.
Today, many people may think that cannabis will soon be legal in all 50 U.S. states. What remains to be seen, however, is whether the growth in sales of this commodity will correspond with good returns for those investing today when so much excitement is already built into prices.
How Many Cannabis-Related Companies are Operating?
According to Investopedia, as of October 2019, 17 cannabis-related stocks already trade on the NASDAQ. Companies such as Cronos Group (CRON), Canopy (CGC), Aurora (ACB), New Age Beverage (NBEV) and Tilray (TLRY) are some of the more famous public listed names.
There are also seven cannabis-focused exchange traded funds (ETFs) available to investors. Many of these are comprised of Canadian-based companies.
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Cannabis Boom and Bust?
Are marijuana-related stocks a good investment now? Or are they simply too speculative for long-term investors?
One might say they have already gone through a mini bubble-burst. Over the last few months, shares of TLRY, CGC, ACB and CRON are down massively between 38% and 45%. This has occurred after being high-flying media darlings over the last few years. Tilray, for example, peaked at almost $150 per share in October 2018 and is currently valued at $22 per share - a decline of almost 85% so far.
Even so, typical market valuation metrics suggest that cannabis firms may still be expensive based on current levels of sales and profits. Company value versus earnings is one such market yardstick. Companies such as TLRY, ACB, and CRON have negative earnings to date, giving their enterprise value (EV) over earnings (EBITDA) negative multiples. By contrast, other “sin” firms such as alcohol and tobacco companies, with their long histories of profitability and massive cash flows, have positive and much more reasonable valuations given their far lower risk profiles.
The cannabis market is young and no doubt is likely to grow, perhaps meaningfully in the years and decades to come. However, competition is intensifying and it is far from clear who the ultimate winners will be. Until recently, the excitement had already driven their prices up tremendously, long before these firms have any real and sustainable earnings to justify their valuations.
Using Ben Graham’s definition above, investors in cannabis today are more likely to be speculating, ie gambling on the future of cannabis, rather than investing in something that is likely to preserve their investment as well as offer a return on top. Of course, not all speculations are bad, and some even work out very well in the end. The important thing is to be aware of the distinction and size your investment appropriately, if at all.
Ridgewood: Your Long-Term, Risk-Mitigating Investment Partner
Given its growth potential, it may be reasonable to place a small percentage of a portfolio in a few well-selected “speculative” investments in this area, but only after doing your homework.
Someone as wise as Warren Buffett quipped that he has three piles on his desk, YES, NO, and TOO HARD. Fortunately, in investing it is not necessary to select investments from the TOO HARD pile in which many speculative opportunities often belong.
Ridgewood Investments focuses on sound, long-term investing in a wide variety of proven markets. Whether or not opportunities in the Cannabis sector turn out to be a good idea in the fullness of time, having an advisor like Ridgewood Investments on your side can really help you to get the most out of your investment opportunities!
About the Author
Kaushal “Ken” Majmudar, CFA founded Ridgewood Investments in 2002 and serves as our Chief Investment Officer with primary focus on managing our Value Investing based strategies. Ken graduated with honors from the Harvard Law School in 1994 after being an honors graduate of Columbia University in 1991 with a bachelor’s degree in Computer Science. Prior to founding Ridgewood Investments in late 2002, Ken worked for seven years on Wall Street as an investment banker at Merrill Lynch and Lehman Brothers where he has extensive experience working on initial public offerings, mergers and acquisitions transactions and other corporate finance advisory work for Fortune 1000 companies. He is admitted to the bar in New York and New Jersey though retired from the practice of law.
Ken’s high level experience and work with clients has been recognized and cited on multiple occasions. He is a noted value investor who has written and spoken extensively on the subject of value investing and intelligent investing. He has been a member of the Value Investors Club – an online members-only group for skilled value investors founded by Joel Greenblatt, SumZero – an online community for professional investors, and has also written for SeekingAlpha – among others. Ken is active in leading professional groups for investment managers as a member of both the CFA Institute and the New York Society of Securities Analysts.