Cannabis stocks in the last quarter of 2018 were defined by a revaluation of the sector to the downside by (on average) 40% from the highs of 2018. Cannabis stocks in 2019, as a whole, will continue to bleed investors. There are two primary driving forces for this discount: a) Increasing number of cannabis issuers with lower quality assets, business plans, and prospects; and b) global macro-economic weakness driving all markets lower.
The latter shows no sign of abating, given that the United States has become unstable, both politically and financially. Without warning and at any moment, there could be a war declared or a unilateral economic decision that plunges the world economy further into darkness and uncertainty. The whole Brexit fiasco has left the world with the impression that while the Eurozone has its issues, they are nothing compared to the infantile squabbling of the British in trying to resolve the issue. China’s data is getting uglier, and so the world is decidedly investor-hostile at the outset of the year.
In the cannabis sector specifically, however, the inability, or unwillingness, of regulators in Canada to protect investors from the unscrupulous market elements that have now thoroughly infiltrated it, represents an increase in risk relative to the potential reward of investing here. The easy money has been made, and now we are awash in charlatans trying to convince us that there is still lots of money to be made in start-ups.
Ironically, this is true.
But the number of startups who will go on to create profitable cannabis businesses, as a ratio, is starting to resemble that more commonly associated with investing in mining start-ups; i.e. one in a hundred, if that.
Increasingly, as in mining, the risk-reward paradigm begins to adopt a more symmetrical geometry, and as more mature companies in the space come to be valued on their balance sheets in 2019, as opposed to their speculative potential, investors will mostly fare better with companies in the growth stage.
As the US moves closer toward federal de-prohibition (a process that might yet still be years in progress, thanks to persistent political dysfunction), we see the vanguard of US charlatans in the space flooding in with the investor-antagonistic Super Voting Structures, which are equivalent to privately-controlled companies raising public money and trading on public exchanges. (This is how gains are privatized and losses socialized)
In Canada, the egregious self-dealing that is legitimized by regulatory approval, will continue to infect investors mouths with bitterness, as the insiders who fund these structures exit ahead of the investors who take the valuations higher with earnest money.
So yeah. The outlook is bleak for investors in the publicly traded cannabis space as a whole.
Here’s what to look for in cannabis issuers with a real shot at delivering a profitable experience to investors:
- Fair and balanced capital structure – If you see company has issued 200 million plus shares to early investors at a nickel a share, that means that you have 200 million shares with a 5 cent cost basis standing in front of you ready to sell you their shares at whatever price you bid. The stock will likely not go higher unless those shares are escrowed, or otherwise restricted. Oh yeah, and make sure all shares carry the same number of votes.
- Engagement with Legitimate Financial Communications Service Providers (Yes, Midas Letter is one). As we’ve seen as a result of the BridgeMark Group scandal , there are operators on the periphery of the industry who collude with less-than-honest management teams to steal investors’ money without actually providing any coverage. If a company is mentioned, or has any affiliation with and of the names on the list, stay away.
- Grill Management: You have the right to ask management anything you want. Ask how much they pay for licenses and assets, and who they dealt with. Was there any prior affiliation among the parties? Does the valuation for the license or facility announced jibe with other transactions in the same area? Are there weird conditions required for the deal to close, or oddly generous incentives to any party for the deal to close? If you don’t get answers that make sense, and that you can verify, don’t invest.
Midas Letter is provided as a source of information only, and is in no way to be construed as investment advice. James West, the author and publisher of the Midas Letter, is not authorized to provide investor advice, and provides this information only to readers who are interested in knowing what he is investing in and how he reaches such decisions.
Investing in emerging public companies involves a high degree of risk and investors in such companies could lose all their money. Always consult a duly accredited investment professional in your jurisdiction prior to making any investment decision.
Midas Letter occasionally accepts fees for advertising and sponsorship from public companies featured on this site. James West and/or Midas Letter may also receive compensation from companies affiliated with companies featured on this site. James West and/or Midas Letter also invests in companies on this site and so readers should view all information on this site as biased.