If you are looking to invest in cannabis stocks & cannabis investing this may be one of the best times to do so. Now, there have been many before me that have said that and investors have had a difficult time profiting from cannabis stocks. There is a lot of hype in the industry for cannabis investing. Here on my site, Cannabis Investing Newsletter, I have removed as much of the hype as possible and distilled investing in cannabis stocks down to the fundamentals of any individual company. By doing that, an investor can weed out the good, the bad, and the ugly, and make informed decisions about cannabis investments.
There are many undervalued marijuana stocks. And, there are some put stocks that are overvalued that may be more household names and, cannabis investors may be getting involved in these stocks without knowing what the outcome may be in the future. These household names, the bigger cannabis stocks, may not be in a position to ever profit. But, simply because these cannabis stocks are popular, many buy these pot stocks. Knowing what to look for may be the best thing to start out in cannabis investing.
For now, there has been a lot of selling pressure in cannabis stocks, and this is something I wanted to address. Basically, there are many cannabis stocks that it makes sense to go short in selling. But, more and more, a lot of cannabis stocks are being sold indiscriminately across the board.
I look at this as a major buying opportunity for long-term investors in the cannabis industry. So, I wanted to put together an article and video showing why some stocks are excellent opportunities for cannabis investing; they are undervalued marijuana stocks, whereas others are not so viable.
Total Addressable Market (TAM)
Cannabis is growing rapidly in the United States as more and more states start to legalize both medical and adult-use, recreational cannabis usage. Right now, there are some 32 states that are medical-only cannabis legal and an additional 18 state, plus Puerto Rico & Washington D.C. that are adult-use legal for cannabis usage.
There may be a few more states that add in medical use but, mostly the states that are already medical use legal, and it may be that this is as far as the country goes with medical use legal for some time. Typically, anything regarding cannabis usage in any capacity is politicized and you can draw lines around the red states as either being only medical use or still totally prohibited with any form of cannabis.
That being said, the blue states are more progressive and have embraced adult-use, recreational cannabis more readily. This is where more of the concentration of cannabis companies are likely to see higher growth rates. These states are seeing rapid increases in usage and growth rates of revenue and profits.
Usage Levels
In general, about 12.5% of any population on average uses cannabis at any measurable frequency in a given year. Given that, when we look at a state such as California, the Total Addressable Market, or TAM, would be about 5 million people given the nearly 40 million population fo California. This makes California the single biggest market in the United States, and it even beats out the entire country of Canada with a population of only 35M. But, Canada has a unique distinction in that the usage levels tend to be a little higher than other areas. As it turns out, Canada has a more liberal approach to cannabis usage. This pushes the TAM for Canada higher. Canada is pushing closer to 15% in measurable average usage levels.
Growth Rates & Cannabis Invetsing
One of the most important distinctions of cannabis usage is that the growth rate is much more rapid than that of other companies in any economy. As cannabis is being legalized, growth rates are far higher than the broader market.
The S&P 500, on average, has been growing revenue rates at about a 3.5% rate over the past few years. It is important to keep in mind that these 500 companies are a good representation fo the broader economy. There are 11 different sectors in the S&P 500 and this growth rate is an average. Any one company may exceed the average overall. And, some companies are negative for any one year. Still, the 3.5% is a fairly steady rate of growth for revenue.
Still, this gives us a good measuring stick to companies the broader economy versus pot stocks.
Cannabis Growth Rate
As for cannabis, I leave some 100 different companies that I keep track of; you can view them here in a spreadsheet format on The Cannabis Stocks – My Top Picks. To five you an idea of how rapidly revenue is growing with cannabis stocks, of the last few quarters, there was revenue growth of some 7.5% on average over the past four quarters. This rate is double that of the broader S&P 500, and this was just one quarter compared to the S&P 500’s total year growth; cannabis companies are growing at a rate that is 8x that of the broader market.
Expectations for growth are continuously increasing. It is hard to keep track of what predictions are reasonable and what could be realistic. But, the state of Colorado gives us a pretty solid idea of the potential of growth in cannabis. The reason is simple: Colorado was one of the very first states to legalize adult-use, recreational cannabis. In fact, they were the first sovereignty that legalized recreational cannabis in the world. They did so in 2014. The state of Washington legalized adult-use cannabis at the same time, but Colorado started to produce and sell its products a little faster. And, Washington state also was a lot more restrictive with their laws lending for a slower growth rate. This becomes important when you evaluate cannabis.
Profitable Cannabis Companies & Cannabis Investing
The ultimate goal of any company is to become profitable. Most of the cannabis companies I evaluate are not. But of those that are not, some could be. It is just that these cannabis companies are spending a great deal of money to capture future market share. These companies are establishing themselves in new areas and the expense is dipping in to profits. This is not a bad thing at all simply because these companies that are expanding are going to be the bigger, and more profitable, companies in the future.
EBTIDA Profits
There are many stages for a company to move through once it starts out. But, the two biggest are EBITDA profitable and net profitable. Once a company becomes EBITDA profitable, this milestone signals that there is far more success on the way. But, that is not a guarantee. Still, it is a big indicator.
EBITDA simply means Earnings Before Interest, Taxation, Depreciation & Amortization. Basically, there are two main parts to a cannabis company (Or, any company for that matter). The two parts are production and operations.
Cannabis Production
If you are breaking down a cannabis company to find undervalued marijuana stocks, the first place to look through the financial documents in a pot stocks is the revenue statement. The top portion, the first portion is where Gross Profits are determined. This is revenue of a cannabis company minus the cost of goods sold which shows the gross profits. This is the breakdown of the production of cannabis companies.
Production means just that: producing a produce. For cannabis companies, this entails three main steps: Growing cannabis, Processing cannabis, and ultimately, Distributing cannabis as in a dispensary.
A cannabis company can entail all three steps in the process, or just one or two of these. Pot stocks that have all three steps are considered “fully vertical”. I believe that a company that has a dispensary may have a slight advantage versus companies that do not. But, a company that sells a premium product may not necessarily need to have dispensaries to succeed in the future. Still, over the longer period, I believe that there is going to be a lot of consolidation in the cannabis industry and that pot stocks are likely to merge.
What happens in the financial statement at this point is you have total revenues. Then, from these total revenues, cost of goods are deducted. This shows gross profits. If divide gross profits over total revenue, this shows the gross margins of a cannabis company. The highest gross margins are the most preferable. I see companies printing about 60% – 65% in gross margins (You are looking for the highest possible number). These are solid-performing cannabis companies. But, a pot stock that has higher gross margins may show that this is the first hint this is an undervalued marijuana stock.
Operations
The other major portion of a cannabis company outside of production is the “corporate” side of the business. This encompasses SG&A and when you look through a revenue statement, it is listed in the second portion of the company’s information.
After breaking out the cost of good sold of cannabis companies, total operating costs are deducted to determine operating profits of cannabis companies.
I often talk about a cannabis company’s operating efficiencies. This is the operations total cost versus the total revenue. It is a percentage. In this case, you want the lowest possible number versus the highest possible gross margins as explained above.
One thing to note is that in this step, in order to calculate EBITDA profitability, you must add back in the Depreciation & Amortization that are deducted out of total operating costs.
EBTIDA Profitability Comparisons & Cannabis Investing
Once we see what cost margins are, we can now start looking at EBTIDA on a percentage basis. Cannabis companies that are retaining the highest rates of EBITDA profits versus the revenue they are earning are ones you might consider the best performing cannabis companies and, these pot stocks are likely to be undervalued marijuana stocks.
Of the 100, or so, cannabis companies that I follow on the Complete List of Top 100 Cannabis Stocks, only about 30 – 35 of these companies are EBTIDA profitable. The rest of these companies have yet to achieve this all-too crucial milestone.
I am frequently asked what is one thing to look for when trying to sort out undervalued marijuana stocks, and this is the first thing I look for. A cannabis company that has achieved EBITDA profitability can, from this point, increase revenues and through marginal costs and marginal profits, scale up and get to the point where they are net earnings profitable.
EBITDA failures
Here are two interesting companies that are not EBTIDA profitable: Canopy Growth CGC Stock and Aurora Cannabis ACB Stock. Both of these two cannabis stocks were hailed as likely to dominate the cannabis industry. As it turns out, neither of these two cannabis companies are able to either consistently grow quality cannabis at a profitable price level, nor can either of these cannabis companies sell product on a consistent basis.
This is likely to be the biggest obstacle in cannabis investing. These two companies are the sort of go-to companies when anyone looks for undervalued marijuana stocks. But, these companies have yet to achieve EBTIDA profitability, nor do I expect them to do so any time soon. But, mainstream retail investors usually jump in to these stocks because they are the pot stocks they have heard the most about.
Undervalued Marijuana Stocks & Cannabis Investing
As it turns out, there is a large buildup of short interest in pot stocks and this is presenting itself with an opportunity to invest in profitable pot stocks; these are undervalued marijuana stocks.
This short interest is merited with companies like Canopy Growth CGC stock and Aurora Cannabis ACB stock. But, not so much with Trulieve TCNNF Stock, one of the best cannabis stocks you can buy. However, these are companies that I wonder if they will be able to continue over the longterm being solvent as they have very high operations along costs, low gross margins, and ultimately may run out fo cash. To be sure, Canopy Growth has some $1.75B in cash remaining. But, they burn through some $150M in cash every quarter. They will have to raise cash somehow or, take a different pathway forward.
That being said, a lot of other companies are being sold during this time. There is barely any traction in cannabis stocks. This despite the fact that some companies, such as Trulieve TCNNF stock, are profitable.
Make certain to check out the best cannabis stocks – my top picks.
MariMed Versus the S&P 500
In the accompanying video to this article I put together a comparison of MariMed versus the S&P 500 average. Here is how the two compared:
- Gross Margins: 43.53%
MariMed: 59.3% - EBITDA Margin: 21.1%
MariMed: 39% - Operating Margin: 17.23%
MariMed: 37.5% - Net Margin: 13.16%
MariMed: 23.3%
There are 500 companies in the S&P 500. On average, you can see how well the S&P 500 compares versus one of my Top Picks. The averages for the S&P 500 are strong, generally. But, keep in mind that these are averages. One company could be well above average with revenue growth whereas other companies are printing negative numbers versus the average of the S&P 500.
That being said, MariMed MRMD stock is one of my Top Picks; MariMed outperforms the averages for all cannabis stocks. But, there is a significant difference with MariMed: MRMD is significantly undervalued versus the broader market indexes.
Cannabis Investing & forward earnings multiples
The S&P 500 is trading at about 40x forward earnings multiple. That is the average for all 500 companies. Just with all averages, there are some companies that are trading well above this and others trading well below this average.
For cannabis investing, and buying undervalued marijuana stocks, I always apply a bigger number with forward earnings multiples. Typically, I use 100x future earnings. I do this because revenues for cannabis stocks increase QoQ significantly faster; look no further than the rate of increase in revenues. The S&P 500 prints about 3.5% increase for the year for revenue increases whereas, pot stocks printed 7.5% the past quarter alone.
Cannabis Investing & Undervalued Marijuana Stocks
Given the rate of growth of revenue growth, the outperformance in margins, it is easy to see why some cannabis stocks will outperform the broader stock market. But, for now, there are a multitude of undervalued marijuana stocks. I see this as an opportunity as many in the industry, many undervalued marijuana stock, or pot stocks, will catch up and increase in value.
In the meantime, MRMD, since the beginning of this year, is up a solid 100% whereas during the same time the S&P 500 is up only 25%.
Good article, greatly helps to put the cannabis world in better perspective.