Thematic Investment: Healthful Cannabis
There were several mentions of medical and healthful applications of Cannabis in the media as the fashionable investment for the year 2018, following cryptocurrencies in 2017. We will see that this sector should not be considered as a suitable investment for a sizeable portion of one's net worth. This is a possible volatility play for an allocation of no more than 1% of one's net worth.
Rationale for the growth of the Cannabis investment market
On Meb Faber's podcast 133, the host discusses with a Cannabis Investment Evangelist Todd Harrison the case for Cannabis health and medical use, and the investment landscape.
Todd makes sees four opportunities for investors: -1 Timing of policy change -2 Slowness of institutional flow, -3 General public perception which is due to change in the coming years, and -4 Liquidity issues around what are currently small investments
Let's review the largest stocks discussed in the seeking alpha article:
- Can Group: CNGGF mkt cap 196m, P/S 125, earning yield -3%, growth 17%, EBITDA margin -250% net margin -314%
- Supreme Cannabis, SPRWF, mkt cap 184m, P/S 29, earning yield -5%, growth 650%, EBITDA margin -175% net margin -84%
- Terrascend, TRSSF, mkt cap 429m, P/S298, growth ???, EBITDA margin -920%, net margin -621%
First, these companies are comparatively small and they lose money, a large proportion of investment in them should result in a total loss of capital. For those that survive, one should consider that for a profitable and established company, a normal P/S ratio is around 2. If the market was to suddenly apply these criteria to these company, the price would drop by 99%.
Some complain that Apple or Amazon are priced for perfection. These stocks are not priced for perfection. They are priced for a miracle.
While one can expect most of these stocks to go to 0, and some of them to lose 99% of their value, the market is pricing the long tail event that one of them grows suddenly, captures much of the Cannabis market and delivers a return that compensates the right investor.
The Cannabis investment landscape has all the hallmarks of an exuberant and wild sector reminiscent of the dot-com mania:
- evangelists who deliver on a narrative,
- unprofitable micro-cap companies set up to cash in on IPO
- possibly pump and dump artists
Meb Faber suggested that an approach that would make sense would be similar to the one for venture capital investing: invest in many companies, after applying a filter on company quality as most companies will fail and a percentage of the companies will generate all the positive return.