Why Do Marijuana Stocks Keep Crashing?

The last few Charts of the Week have offered dense looks at inflation and offered predictions about the declining value of the dollar. 

This week, let’s do something more fun. 

In this Finance Daddy issue, I give an example of a stock that seems to defy logic and gravity. 

This is what happens in a bubble, when stock prices go up even though there seems to be no real reason behind it. 

Here, I wanted to emphasize that point by showing the reverse: what happens when a market goes down despite steadily improving financial performance. 

We’ll use one of my favorite booming markets as an example: Cannabis. 

The seas have been rough sailing for cannabis investors. 

Despite being legal for recreational use in Canada since October 2018 and legal in a number of American states…

Cannabis stock investors have had to watch their holdings spike and tumble.

You can see this if you look at the S&P/MX International Cannabis Index. This index tracks the performance of companies significantly involved in the cannabis market. 

The index has declined about -40% between February and August 2021. (The S&P 500 is up about 14% in that timeframe.)

If we were only looking at price, this would feel like a terrible investment. After all, it seems like these companies won’t stop going down!

But price doesn’t tell the whole story. It certainly doesn’t tell you about the health of cannabis companies.

Let’s look deeper. 

There are two cannabis ETFs I like: the ETFMG Alternative Harvest ETF (NYSE: MJ) and the AdvisorShares Pure US Cannabis ETF (NYSE: MSOS). 

ETFs are like funds containing a big basket of stocks, except you can buy and sell them in your brokerage account like any other stock. 

ETF holdings are publicly available. You can just type a ticker symbol and “etf holdings” into Google to find a list of stocks. 

That’s what I did to find the top five cannabis holdings in MJ: GRWG, TLRY, CGC, ACB, and CRON. 

Now, like the cannabis market overall, these stocks have seen significant price declines. 

But if you look at their revenue growth, we see a different story. 

All five companies, except for ACB, are seeing fantastic sales growth. 

It’s the same story if we look just at U.S. companies, which is the focus of MSOS. The top five companies in MSOS are: GTBIF, CURLF, CRLBF, TCNNF, and AYRWF. 

(These are all examples of “OTC tickers.”)

And here is the most up-to-date revenue data we have on them:

So why are these stocks going down? 

Well, for one, while most of them are seeing revenue go up, none of these stocks are very profitable… or profitable at all. 

Secondly, because many of these stocks are unprofitable, they often raise cash by issuing and selling more stock. This is called “share dilution.”

This makes a business “healthier,” because now the business has more money to operate. But it punishes shareholders and reduces share prices, since each share now represents a smaller percentage of the company.

Bottom line, the price of cannabis companies and the growth of the cannabis market are telling two different stories. 

The broader macroeconomic story of cannabis remains the same…

The legal cannabis market is a gold mine in Canada, the U.S., and the world. Sales are expected to double in the U.S. by 2023… even without federal legalization. 

Many legislators are determined to legalize cannabis in the next several months. Draft legislation has been released and senators are meeting with the White House to discuss legalization. 

There is still a kind of “Green Gold Rush” happening in the cannabis space. Companies are going to be raking in billions.

But until these companies stop punishing shareholders with dilution and terrible profit margins, this market is going to be rough on impatient investors.

As for the patient ones, they’ll stand to make a killing.

“SO HOW DO I INVEST TO PROFIT FROM CANNABIS LEGALIZATION?” 

Look into the ETFs I mentioned above, the ETFMG Alternative Harvest ETF (NYSE: MJ) and the AdvisorShares Pure US Cannabis ETF (NYSE: MSOS). 

Don’t bet the farm here, if you do invest. It’s entirely possible these stock prices will continue to decline in the short term, even if cannabis is legalized.

But at the same time, if you’re willing to wait 6, 7, or even 10 years… 

The cannabis market looks like an extremely attractive investment at current prices.