Get Started In Cannabis Investing – 5 Things To Know

Cannabis Investing may be the best opportunity you have to achieve wealth.  How do you get started in cannabis investing & how to read financial statements?  What are cannabis investments, and how do you read financial statements?  Anyone who has looked into cannabis investing for the first time may be quickly overwhelmed.  But, the allure is significant with what could potentially be a life-changing investment opportunity such that cannabis investing can offer.

I am D. H. Taylor, the author of this website & newsletter, and have been involved in the markets on a professional level for over 30+ years.  What I do is break down all of the information for people just like you.  Here in this article, you will find a breakdown of how to interpret all of the financial information you may encounter in financial statements but, most importantly teach you how to interpret this information so you can learn how to make smart cannabis investments.

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Cannabis Investments Abound

There are a lot of opportunities with investing but, cannabis investing may offer the biggest opportunity of them all for long-term investing.  Where do you start?  What should you look for when considering cannabis investments?  And, once you have chosen a company, what do all of these financial numbers mean and how do you interpret them?

On this site, you will find some 350 different cannabis investments that I have already sorted through making it easy for you to find the right investing opportunity.  I have broken down the revenues, costs, margins, cash on hand, and all of the other pertinent financial data so you can easily sort through the ton of information.

Where to find information for cannabis companies

There are many different financial websites out there that post financial data for any publicly-traded company.  They offer a good glimpse of financial data for these respective companies.

Don’t use these financial websites.  They are always wrong.  Always.  And, the last thing you want to do is rely upon inaccurate information.  In fact, I used to contribute content to Seeking Alpha, a financial website.  I often used their financial information only to find out I needed to go back in and update the content with more accurate information.

Where to go, then?

Find the respective company’s Management Discussion & Analysis, or, MD&A.  First, you know the information is accurate; it is coming directly from the company.  Also, generally peppered throughout these documents are management notes on what is happening, explanations, and expectations.

Usually, on the company websites you will find links to Investor Presentations or, also you may find press releases relating to financial earnings.  These are usually where I go to find documentation.

Another great resource is the various exchanges.  I like to go to The OTC Markets Website for financial data for companies.  Cannabis companies are required to report to these exchanges.

Cannabis Companies & How To Read Financial Statements

There are three main sections of a publicly-traded financial statement: Income statement, Cash Flow Statement, and Balance Sheet.  While there all three sections of a financial statement are important for different reasons, to start we will focus on the income statement for any of the cannabis companies.

It all starts with revenues. Revenues are the total amount of money generated for selling products.  Revenues are at the top of the financial statement in the Income Statement; we call this the Top Line.  But, do not confuse revenues with income.  Income, or net income, is actually at the bottom line.

Unfortunately, revenues are not where cannabis companies begin.  Cannabis companies start with a dream.  They will then put that dream onto paper and hopefully be able to execute that plan.  Facilities for growing and processing of cannabis products need to be created and built.  The eventuality is that cannabis companies will be able to sell their products and create revenue.

Creating Revenue

As mentioned, there are three main sections of a financial statement: Revenue is at the top of the financial statement and is usually the first go-to for investors when trying to determine how a cannabis company is performing.

But, how high is high?  How big is big?  How many are many?

I want you to keep these two important principles in mind as we travel through this tutorial: Investing is not an event; it is a process.  And, you have to look at both the forest and the trees to get an understanding of everything.

Understanding comparisons for cannabis investing

The above questions: How high is high, etc., believe it or not, are important.  I have a dual major in both economics (Macroeconomics) and applied mathematics (Statistics).  So, studying statistics and numbers is in my blood and on my mind with everything.

People often speak in what could be called “bumper sticker” terms or, what could be called platitudes.  Often, people regurgitate quick informative bites but unfortunately, they may have no basis for saying these things.  I caution you from getting too deep into listening to these and taking them for their word.  This, after all, is investing and involves your hard-earned money.  And as with any discussion lately of politics shows, a lot of people genuinely have no idea what they are talking about.  This is YOUR money.  You need to get this right.  So, if you hear platitudes or bumper sticker slogans with a potential cannabis investment, take that information with a grain of salt and dig a little deeper to uncover the actual facts.

Back up your statistics

Given that, if someone says a statistic, you may want to know how to quantify that statistic.  For instance, it is hot outside today.  What exactly does that mean?  What time of the year is it and is this unusually or unseasonably hot?

Understanding a baseline allows for someone to get a solid grasp of what that means.  This may seem off the focused path, but if you think about it this is very crucial for an investor.

Understanding the top-line & bottom-line

If someone says that the company was very profitable this quarter, what does that mean?  What is the basis of this statement?  Most importantly, how does that compare to other companies in the sector?  So, if someone were to say to you that a company was very profitable, knowing how to make comparisons will lead you to be able to grasp that statement as being either valid or not.

For example, maybe you have received a paycheck in your lifetime.  The ‘top line” is the aggregate of earnings from say, working 20 hours and earning $15.00 per hour, or in this example $300.00.  But, the government always wants their cut.  So, taxes are taken out of your revenue.  Then, at the bottom, you get to see what your bottom line, or, income, actually is.  Make certain you have a grasp of that.

Top-Line

This is no different for cannabis companies.  There is top-line revenue and this is an oft-quoted number.  We want to know how much revenue was generated by the company.  But, there is more than one type of revenue and there are different input levels for different kinds of revenue.

And, there are also costs associated with this revenue and as we work down the income statement you will continually see deductions from the revenue line.  It is no different than your paycheck.  At the very top is your top-line income.  But, the government and other types of deductions are taken out along the way until you finally get to the bottom line where you can see the actual amount that you can deposit into your bank.

Top Line Revenue – Cannabis Investing & How to Read Financial Statements

Let us use this simple concept to understand the basics of an income statement.  We will do that by creating two fictional companies to show how to look at financial statements and compare one company to another.

Look at these numbers:

[wpdatatable id=18]

Here we have financial revenue for two companies over 8 quarters; Company A & Company B.

Question: Which one is better?

Answer: We have absolutely no idea.

What can we tell?

But, what can we tell?  We can tell a lot about the total picture of revenue over the past 8 quarters.  However, that is all we know about these two cannabis companies, their respective revenues.  Whether or not either of these companies would be a solid cannabis investment is unknown at the top line level.

At the same time, although we have a lot of information regarding the revenge picture over the past 8 quarters for two companies, revenues are a small part of the total picture.

But, let us break down what the above revenue, or, Top Line picture looks like.

QoQ & YoY

Maybe you have seen these little abbreviations and had no idea what they were or what to do with them: QoQ & YoY  What is it and how does someone use it in cannabis investing.  First, they are abbreviations for Quarter-over-Quarter and Year-over-Year.

As investors, we compare one quarter to another to determine how the performance of one quarter is versus another quarter or one year to another year.  What we are generally looking for are growth rates.

In the case of, say Q1 2020 for both companies we can determine two things: QoQ from Q4 2019 to Q1 2020 and we can also compare YoY Q1 2020 to Q1 2019.  These comparisons are very important to determine how well a company is performing.

How to Read Financial Statements & Mathematics

Let me introduce some mathematics into the equation as this is important in figuring out these numbers and how to read financial statements.  Look at Company B, Q2 2019 v Q1.  We see the numbers $52 and $50, respectively.

The math is simple: Take the Q2 number and subtract the Q1 number and then divide that remainder by the Q1 number.  So, in this example, you would subtract $52 – $50 = $2.  Then, divide the $2 by $50.  You are left with a small number of: 0.04.  That is a percentage of 4%.  (Please note: It is entirely possible to have a negative number or a decline in revenue from one quarter to the next).

The growth rate for Q2 was 4% QoQ.  You can look at all of the various quarters like this and determine which company is growing more rapidly with revenue every quarter or on an annual basis should you look at quarters from one year to the next.

Which is better?

So, which company is the better cannabis investment?

Still, we are not certain about whether or not either Company A or Company B would be a solid cannabis investment.  All we can tell from this picture is what the growth rates are for revenue and nothing more.  We still need to gather more information.  Remember, I said that you need to see both the forest and the trees to understand the whole picture.

Cannabis Investing: Cost of Goods, Gross Margins, and Gross Profits

To get more information, we move down the incomes statement a bit more.  Below is a more complete look at Company A’s Top Line Revenue along with cost of goods, gross margins, and gross profits:

[wpdatatable id=19]

Let’s define what these metrics mean to better understand how to use these numbers.

Cost of Goods Sold

Cost of goods sold is the direct cost of producing the goods sold by a company.  There are several different costs associated with a business.  Cost of goods sold will be the first and main one to look at.

This is all of the input costs there are with creating the product.  With regard to cannabis companies, this could be the rent on the grow facility, electricity for the grow lights, cost of seeds, nutrients, labor to plant, harvest, trim, and process the cannabis, packaging of the product, and so much more.

What happens is these costs are aggregated and then subtracted from total revenues.

Gross Margins

One of the most important metrics in this portion of the revenue statement is Gross Margins, and gross margins are a very important metric to keep an eye on. They are a mathematical formula showing the total remaining amount of money left over after deducting cost of goods sold from revenue and then dividing by total revenue.  This gives us a percentage and, you want the highest number you can get.

After reviewing some 350 different cannabis companies I have found that the best cannabis companies are hitting approximately 60% – 65% in gross margins.  This means for every $1.00 in revenue the company is keeping some $0.60 – $0.65 for gross profits.

This is an important metric to compare one company to another.  If two cannabis companies sell the same amount of goods in revenue and one company has a higher gross margin, then that company is outperforming the other.  Companies are always striving to have the highest gross margins and, you would want to invest in a company that has the highest possible gross margin relative to another cannabis investment.

Gross Profits

The last line on this mini revenue statement is gross profits.  Gross profits are those profits after cost of goods is deducted from total revenues.  From this line more costs will be deducted but, we will get into that in a moment.

Now that we have a fundamental understanding of these lines in the financial statements we can compare two companies to each other.

Is Company A a good cannabis investment?

As I said before, I evaluate some 350 cannabis companies.  After having reviewed so many companies I can tell you Company A could actually be a company I look at regularly.  The revenues above are normal for cannabis companies.  These companies are just gearing up and are starting to see revenue gains.  Then, all of a sudden there may be a sharp increase in revenue in one quarter versus the previous.  This could be a result of a number of factors.

Likely what has happened at that one point is new production came online and Company A began selling this product; there has been a significant increase QoQ.  I try and not to look at YoY increases after this simply because these are distorted.  Still, this could tell a potential investor that this would be a good company to look at for potential cannabis investing.

Is Company B a good cannabis Investment?

Here is a look at Company B’s Top Line Revenue along with cost of goods, gross margins, and gross profits:

[wpdatatable id=20]

Now we can compare the first part of the revenue statements from Company A & Company B, this will give us an understanding of which company may outperform the other.

More is less

As you can see, Company B has more revenue every quarter.  But, the growth of that revenue is not as high as Company A’s and as a result, neither is the revenue growth rate.  Again, this could easily be a company I am looking at during any period of time throughout the year.  I see many larger cannabis companies that are producing and selling a significant amount of cannabis products.

But, if there is one thing I have learned by evaluating so many cannabis companies it is that while it is easy to grow cannabis, it is very difficult to consistently grow excellent cannabis… and, expensive.  Therefore, a company that can learn to grow excellent cannabis, become consistent with that, and does so on a level that is inexpensive would be a solid cannabis investment.  I am not so sure that in this example above Company B, albeit fictional, would be a good cannabis investment.  Keep in mind, I see these kinds of numbers with actual cannabis companies all of the time.

Cannabis Investing & Operating Costs

There are four main sections to the income statement.  The top portion is dedicated to revenues and the direct cost of creating a product, and we end up with what is termed gross profits.  Next, there is the next section that gives us operating profits.

What are operating profits?  The answer lies in how we look at the next major cost listed in the income statement.  There are two broad categories that fall into this area of total operating cost that is comprised of SG&A and Depreciation & Amortization.

Operating costs will encompass these costs.  Along with operating costs is a metric I really like looking at: Operating efficiencies.  From the operating costs, we can see how this section breaks down.

Operating Efficiencies

Operating efficiencies are a percentage derived from dividing total operating costs by total revenues.  This gives an investor the potential to evaluate how efficiently management is at producing products.  Whereas gross margins tell us how much it costs for a company to produce a product relative to revenues, operating efficiencies tell us how efficient management is relative.

At the bottom, we see Total Operating Profits.  This number is derived from subtracting cost of goods sold from the previous section and total operating costs.  This gives us operating profits.

Let’s look at our fictional companies, Company A & Company B with operating costs versus revenues and operating efficiencies:

Company A Operating Costs

Here is a look at Operating Costs for Company A:

[wpdatatable id=21]

You may notice that operating costs rose sharply over the past few quarters for Company A.  Most likely, in this scenario, as the company geared up to sell more product back-office operations ramped up with in-kind increases.  Look below for a detailed explanation as to what is inside these metrics to understand why this makes sense.  Towards the end of the statement, we can see that on a relative basis, Company A’s efficiency is improving.

What to look for

I look at some 350 different cannabis companies and am breaking them down to show how all of these companies compare to each other.  What I have found is that operating efficiencies for the best companies come in around 30% – 35%.  But, there are a few that show up in the mid-20s; these companies outperform relative to other companies.

Given this, Company A was in a period where they were gearing up production.  We figured this out from revenues in the previous section.  Now, in the operating costs section, we see that Company A ramped up capabilities operationally, in order to sell the product they produced.

In general, this company is very similar to what I see regularly for cannabis companies.  There is a period of low revenue and costs.  Then, all of a sudden there is a sharp increase in revenue and costs as the company starts to get into the full swing of its potential.

Company B Operating Costs

Here is a look at Operating Costs for Company B:

[wpdatatable id=23]

First, notice that all of the operating costs are basically the same, but as revenues increase you will also notice that on a relative basis operating costs are smaller each quarter comparatively.  Again, you want the very smallest possible number, and, as mentioned, this is a relationship that is dependent upon revenues.  As revenues increase and operating costs remain the same, you will notice that there is a continued decline in operating efficiencies (A smaller number which translates into relatively better efficiencies).

To big too fast

Usually, operating costs increase as revenues go higher; companies will take on more costs to sell more products.

Another observation you should make is that Company B is very similar to some of the larger companies I look at.  What happens is you get a CEO or management in general, that has experience running a company.  They know there are aspects of a company that simply cannot be functional without. They implement these practices and this incurs costs.  What happens is that these larger companies drive up costs well ahead of the completion of product development with an expectation that having these practices in place will equate to better overall management, despite being expensive.

Is this a good thing, or a bad thing?  My take on this is that on the one hand if a company wants to perform like a large company they need to act like a large company and not forego these crucial aspects of running a company.  But, at the same time, there may be a cash burn rate that is painful. In the end, there needs to be a balance between creating the foundation and growing the business.

Total Operating Profits

Total operating profits are profits for the company after cost of goods and total operating costs are deducted from revenues.  This is the “core” of the business operations, so this is a very important metric and a go-to for evaluating a business operation.  There are a few distinctive lines inside Total Operating Costs that I want to break down.

What is SG&A in an income statement?

What is SG&A?  SG&A stands for Sales, General, And Administrative.  These are costs associated with running the business but not costs associated with directly producing the product.  Yes, there is a difference.  And, it is important that these costs are differentiated and looked at with just as much scrutiny.

These costs are important and I often refer to them in my videos.  While production costs tell us how inexpensively, or expensively, a company produces products relative to total revenue, total operating costs tell us how efficiently management is relative to revenues.

Operating Efficiencies

One of the reasons why I love this metric is that this gives us a good idea of how efficiently management is with operational costs.  By looking at the individual costs on their own you can get a good sense of what management is up to.  And, you can also see how frugal a company is compared to other companies, something I like very much.

Neither you nor I have the ability to spend significant amounts of money to determine if management has a tremendous amount of integrity.  But, we can see in this one metric how management compares to other company management teams; this gives us a good sense of management’s intentions and commitment to creating investor value.

Let’s break down each of the three main areas of SG&A.

Sales

This is the sales force and marketing department of a company.  Some companies do a pretty good job of breaking out these metrics in their respective MD&As.  There is a fairly strong correlation between the amount spent and increases in revenues; after all, this is the department responsible for selling the products.

General

General are costs associated with running the business such as rent on the corporate building or other aspects of business operations.

Administrative

Administrative refers to costs for the administrative section of the business that are likely to show salaries and other expenses.  You may find the CEO salary in this section of total operating expenses as well you may find expenses related to options and employee compensation.

Depreciation & Amortization

Every company can write down costs for expenses of purchases of equipment and other expenses.  Also, amortization deals with lowering the book value of loans.  These two deductions show up in Total Operating Costs.

EBITDA… what?  And, why is EBITDA so important?

What exactly is EBTIDA and why is it important?  First, EBITDA, a non-GAPP metric, is a measure of Earnings Before Interest, Taxation, Depreciation, & Amortization.  So, you need to look at Total Operating Profits and then break out the deductions of depreciation and amortization.  This gives a basic breakdown of the very core of the company.

Effectively, a company makes a product and then sells it.  What did it cost to sell the product and what does it cost to run the core business?  There will be other costs a company incurs such as financing costs.  But, these are outside of the general core of the company.

Breaking Down EBITDA’a Importance

EBITDA tells us if the cannabis company’s core operations will be profitable.  A company will have revenues, the costs to produce the product, rent, and other expenses associated with product costs, and then running the business.  This is the core of the company outside of non-normal costs for the business.  If a company can sell a product at a certain price and pay for the costs of producing the product as well as paying for the operations of the company then this basic company plan would likely be profitable and earn net income in the future.

After achieving this basic profit level then it is a question of the company scaling up operations and producing/selling more product.  With marginal profits and increased production/sales of products, then the eventuality is that a cannabis company would achieve net income positive earnings.

Therefore, achieving EBTIDA profit is a goal of every new business.  There is a multitude of factors to achieving EBTIDA profitability such as increasing margins and containing costs.  Factor those two dual goals along with increasing sales and revenues and you can see how this plays out for a company.

Cannabis Investing & Continuing Operations

Generally, this is the first real target for a cannabis company, and therefore something that we as investors should be watching for.  But, continuing operations are important but, at this stage in the game for cannabis investing we may be off the hook in looking at all of the little numbers inside this section.  Mostly, continuing operations are the section that shows financing costs for a company.  Because most cannabis companies are still in a stage where this section is not as crucial there is less of an emphasis here.

With economies of scale, a company can generally pay for costs associated with running the business such as financing costs.  So, as explained above, the first real focus of a company is obtaining EBTIDA profitability.  Then, with economies of scale, producing and selling more and more product, continuing costs are generally paid for.

Tucked into this section of the Income Statement you may find additional revenues from financing and other outside operations.  This will be minimal compared to other areas of the cannabis company’s main focus, but nonetheless, there may be additional revenues.  And, let’s face it, every bit helps.

Employee Options & Costs

Also, whenever there is a cost associated with a cannabis company that lies outside of normal operations it tends to show up in this section.  For instance, whenever a company has to spend money in order to pay for employee options, and there is a simultaneous large increase in stock valuation, that cost may end up in this section.

Also, other costs associated with M&A activity may show up in this section.  So, by no means is this section a section that should be dismissed.  In the future, however, with some cannabis companies, this section may increase in importance relative to other companies, especially cannabis companies that are having trouble and need extra financing.

For now, however, whenever I am focusing on cannabis companies I usually focus on the first two sections of the Income Statement; revenues and operating costs.

Cannabis Companies & Net Income & EPS

At the end of the day, we are waiting on Net Income and Earnings Per Share.  This section of the income statement may be the most important in that regard.  And, as shareholders, or the potential thereof, this is what it is all about.

As I discussed above, there are three main sections of the Income Statement.  At the very top, you have revenues.  Then, all the way down you continually see costs subtracted from the top-line revenues. At the very bottom, you see what is left over; this is Net Income.

As owners of a public-traded stock this is what we are hoping for; to see positive net income.

Are You Ready to Get Started In Cannabis Investing?

This is a long article and so I want to say thanks for making it this far in this little tutorial.  By no means is this a complete article.  I wanted to merely highlight the important aspects of what we are looking at with cannabis investing right now.  There are at least two more major areas of the financial statements but, I just wanted to focus on this section only.  The reason for this is simple: Cannabis companies are still in the ramping up stages and the other sections are not nearly as important right now.  Eventually, the other two sections will become more and more important and you will want to shift your focus to these sections.

Cash Flow Statement

The Cash Flow statement shows just that, cash flow from operations.  What is important to understand is that right now cannabis is an all-cash business and because of that there is not a real need to look at accounts receivables since there really is none.  Still, some aspects of the business are on a credit basis such as White Label manufacturing and products that flow to dispensaries.  This is a small aspect of the business and so the Cash Flow statement will not be entirely important for some time.

There is one thing that is important in the Cash Flow statement and that is the per-share cash flow from operations.  This is where dividends are derived so, if you are wondering when if one of the cannabis companies will be issuing a dividend then you would want to look at that metric.

Balance Sheet

The Balance Sheet is part of the financial statement that shows a comparison between assets and liabilities.  You would want to keep a sharp eye peeled towards these metrics but, there are also a lot of continual changes in this section of the financial statement.  The reason is simple: Companies are continuously changing capitalization as they grow and their needs change.

I do look at Book Value Per share on a regular basis but, this has more to do with entry points and whether a company has a solid undervaluation compared to what its assets are priced at.  This is a very helpful metric but, they also are constantly shifting so it makes it difficult to assess regularly.

Income Statement

Generally, I find that the real meat-and-potatoes of a financial statement and learning how to read financial statements can be focused on the Income Statement to start.  I have presented some basics here and, these will greatly advance your understanding of how to read financial statements for cannabis investing.

Given the above information, I believe that someone who is brand new to cannabis investing, if not investing in general, would have a solid idea of how to invest in cannabis companies.  If you applied these basic principles and started sifting through financial statements very likely you would find that you are beginning to spot important metrics along the way.  Likely, by following along with this mini tutorial, and by watching my videos on a regular basis, you are already improving in your knowledge of understanding how to read a financial statement for getting started in cannabis investing.

A book on the way

Next up for me is the corresponding video for this article and then I plan on writing an ebook covering this information in far greater depth.  This will take some time for me to produce and, I’m likely to offer it to my followers for free as an ebook (I still have not yet figured that out) entitled: Getting Started In Cannabis Investing.

Getting Started In Cannabis Investing
Getting Started In Cannabis Investing

In the meantime, I am hopeful you have gained some important information regarding how to read financial statements that will help you in how to get started with cannabis investing.  Follow along with my video content and articles and you will learn even more.

And, with cannabis companies getting bigger and more profitable as time goes by, you are very likely to create significant wealth along the way.

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