Investing in Cannabis Stocks: Everything investors need to know

| June 6, 2022

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Investing in cannabis stocks and shares

Investing in cannabis stocks and shares has so far proven to be an unprofitable venture. Despite legalisation making significant strides, these businesses continue to limper on, with many seeing large double-digit declines. This isn’t uncommon in early-stage industries.

But despite what the performance of the last couple of years indicates, analyst forecasts continue to be bullish. Is a turnaround on the horizon? Let’s dig deeper into the cannabis industry, see what challenges these shares are facing, and discover their future growth potential.

What are Cannabis Stocks?

Cannabis stocks represent companies that operate in the production of marijuana or products derived from hemp. Despite the social stigma surrounding this drug, there are a lot of health and medical benefits of the substance beyond recreational use.

Today, this stock market sector is broken up into four categories:

  • Farming – The firms involved in the growing and harvesting of commercial hemp fall under this category. These farmers then sell the produce to processors, extraction groups, or middlemen.
  • Extraction – These companies process hemp plants into usable commodities such as CBD oils, beauty products like skin creams, and other more traditional recreational items.
  • Dispensing – Cannabis-based products have a wide variety which includes products like concentrates, edibles, and vaporisers, in addition to medicines, oils, and hemp. Dispensaries are any firm in the business of selling finished marijuana products to consumers or medical institutions.
  • Ancillary – This is a less talked about the segment. But businesses under this category provide support services to any of the other three.

The Risks and Challenges Faced by the Cannabis Shares

There are a number of challenges that a marijuana stock has to face. And hurdles being set by both society and regulators aren’t exactly easy to overcome. The odds are undoubtedly stacked against them. So, let’s dive into the details.

  • Unknown Regulatory Landscape – Since the industry is new and evolving, the government rules and regulations are continuously changing. This is even more challenging in the US, where federal law and state law don’t always align. As a result, it becomes quite a challenge for cannabis stocks to stay up to date on the shifting regulations.
  • Raising Capital – Many banks and financial institutions do not and currently cannot extend their services to cannabis-based businesses in the US due to federal law. Consequently, raising initial capital to accelerate growth is exceptionally difficult and often results in substantial equity dilution.
  • Marketing Restrictions – There are many restrictions on how cannabis companies can advertise their products. In fact, in many US states and European countries advertising cannabis products is outright banned, even on social media platforms. Needless to say, trying to build consumer awareness of a product that cannot be advertised isn’t exactly an easy endeavour.
  • Social Stigma – Cannabis is still stereotyped as a non-medicinal substance, rightly or wrongly so. But for the businesses trying to sell legal products either to consumers or healthcare, this poses a huge challenge.

Key Financial Metrics to Consider Before Investing in Cannabis Stocks

Maintaining a financially healthy business is very important for success. That’s true for any enterprise but is especially applicable to cannabis shares. As an investor, before investing in cannabis stocks and shares, I believe understanding the financial position is critical in making an informed investment decision.

  • Revenue – Many young companies operating in this space often perform an Initial Public Offering (IPO) before even having a product ready. This is somewhat required due to the high capital requirements and lack of money access from other sources. As a consequence, there are countless pre-revenue cannabis stocks out there. These groups are almost always unproven brands, drastically increasing the risk profile of any investment.
  • Cash Flow – Keeping track of cash flow is essential. Since insufficient cash puts pressure on the cannabis stocks price. If a group doesn’t have substantial cash flows and the cash balance is also low, another round of equity dilution could be on the horizon.
  • EBITDA – This is a very important ratio within the cannabis market. EBITDA removes all non-cash gains of the company and gives a true indication of the company’s operational capability.
  • Tangible Equity – Many cannabis stocks have little to no tangible equity. Therefore, it creates many challenges for raising additional capital. Hence this is a very important metric to know before investing in cannabis stocks and shares.

Key Terms to Know Before Investing in Cannabis Shares

Understanding the key terms of the industry is very important before considering an investment in cannabis stocks. After all, this industry, like many others, has its own dictionary of jargon that’s seldom explained.

  • Fulfilment Turnaround Time – This tells about the period which begins when the user submits the order for “Processing” and ends when the package is ready to be collected by the carrier for shipment.
  • Cash-to-Cash Cycle – This is important amongst cannabis manufacturing shares. It is the period between when a business pays cash to its suppliers for inventory and receives cash from its customers.
  • Manufacturing Cycle – The average length of time from the start of production to the shipment for delivery of the product.
  • Throughput & Capacity Utilisation – Amongst cannabis manufacturers, it tells about the business product requirement.
  • WIP Inventory/Turns – The rate at which a company’s inventory of work-in-process (WIP) materials move on to completion and are replaced or “turned” over a given time.
  • Grow Cycle Time – It is the actual time spent working on growing cannabis.
  • Average Yield – A measure of the yield of a crop per unit area and the seed generation of the plant itself.
  • Yield per Square Foot – This tells about the efficiency of canopy space used.
  • Yield per Watt – This tells about the efficiency based on the consumption of electricity.
  • Production per Acre – The average weight per harvested acre.

Market Size and Forecasted Growth of the Cannabis Industry

The global Cannabis market was valued at $20.05bn in 2020, according to Vantage Market Research. And like many young industries, the projected growth is substantial. The same report forecasts an annualised compounded growth rate of 26.19% until 2028 reaching a market size of $128.92bn.

The cannabis sector is one of the emerging sectors of the economy. The factors that are surging the growth of the global cannabis market are:

  • Rising legalisation of recreational and medical cannabis, globally.
  • The increased social acceptance of cannabis.
  • Awareness about the effective use of medical cannabis for treating specific diseases.

Top Cannabis Stocks in the UK by Market Capitalisation

CompanyMarket Cap.CategoryDescription
Associated British Foods (LSE:ABF)£13.5bnFarmingThe United Kingdom’s largest licensed growers of hemp plants.
Futura Medical (LSE:FUM)£84.54mDispensingCreates cosmetic and pain relief produced using cannabis.
Deepverge (LSE:DVRG)£26.91mAncillary “Grows” artificial skin for healthcare companies to test new skincare products.
Kanabo (LSE:KNB)£16.92mDispensingProvider of medical-grade marijuana and its own vaping device to administer precise dosages to patients.
Cellular Goods (LSE:CBX)£9.89mDispensingSells consumer skincare products based on synthetic lab-produced cannabinoids.

Top Cannabis Stocks in the US by Market Capitalisation

CompanyMarket Cap.CategoryDescription
Jazz Pharmaceutical (NASDAQ:JAZZ)$9.45bnDispensingA pharmaceutical company based in the United States using cannabis to treat childhood epilepsy.
Scotts Miracle-Gro (NYSE:SMG)$5.40bnAncillary A cannabis company suplying hydroponic farming equipment used by hemp growers.
Innovative Industrial Properties (NYSE:IIPR)$3.74bnAncillary Invests in properties and facilities which can be leased out to hemp plant growers and product manufacturers.
GrowGeneration (NASDAQ:GRWG)$303.72mAncillary One of the largest speciality retail supply chains providing on-demand hydroponics supplies.
Hydrofarm Holdings (NASDAQ:HYFM)$279.98mAncillary Provides a vast collection of hydroponic equipment used to grow hemp plants.

Should I Invest in Cannabis Stocks?

The cannabis industry is a multi-billion-dollar business. And there’s no denying that market forecasts expect the sector to grow rapidly in the coming years. Even more so now that the US has begun the slow process of legalisation.

However, as with any infant industry, the level of unknowns and risks that comes with investing in cannabis shares is exceptionally high. Having said that, given the potential reward, this is something I’m willing to pursue with my own portfolio.

At the moment, it’s exceptionally difficult to predict which business will become an eventual market leader. Therefore, I believe taking a diversified approach is going to be essential to protect my investments.

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Saima Naveed does not own shares in any of the companies mentioned. The Money Cog does not own any shares in the companies mentioned. Views expressed on the companies and assets mentioned in this article are those of the writer and therefore may differ from the opinions of analysts in The Money Cog Premium services.