Why You Shouldn’t Lose Your Wits Over This Bearish Story
Top marijuana stocks are facing another round of sell-offs, and this time a bearish article by Barron’s may be partly to blame. A Barron’s story titled “Marijuana Stocks Could Be a Buzzkill” went viral this week. To fickle investors, it reeked heavily of pessimism. To me, however, it was actually positive on a number of fronts.
The gist of the story is that a marijuana supply glut is in the making. Soon, growing competition will force legal marijuana producers to engage in price wars. The selling price for marijuana will drop significantly and many producers won’t be able to break even. The losing businesses will fail to justify their lofty valuations and, in turn, their stocks will tank.
The writer’s thesis, on a cursory read, is correct. But it misses out on a few points. A flaw in the article’s line of reasoning is that it doesn’t take into account the fact that, in most cases, Canada’s provincial governments—not individual producers—will be setting the per-gram sales price for recreational pot.
And with most Canadian provinces already procuring their yearly supply of weed from major producers ahead of Canada’s marijuana legalization, the only fair competition that legal pot will face is from the black market. This is where Canadian law enforcement will have to play its role.
To write off all marijuana stocks on the grounds that the black market would thrive better than the legal market is absurd. The black market might continue to perform well in the short term, but, over time, the legal market will take over, just like it has for tobacco and alcohol.
Also, the article doesn’t take into account the fact that many of the large producers are now generating a significantly growing amount of revenue from international sales. So the potential market for these Canadian marijuana companies is not limited to Canada.
There’s no question that the legal marijuana industry is expanding at an unprecedented pace.
Almost a year ago in my marijuana stock predictions for 2018, I forecasted that some marijuana companies won’t still be around in a few years. Either they’ll go out of business or they’ll be acquired by the bigger players.
The premise of my prediction was the same as that of the Barron’s writer. It’s obvious that, with new marijuana growers popping up left, right, and center, the only way the industry can survive is if demand grows in line with supply.
To that end, the Barron’s story about marijuana companies actually highlights a bullish statistic, one that reinforces the demand side of the equation. The writer cites a study that says Canadian teenagers smoke more pot than teens in any other developed nation.
What’s more, in Canada’s largest province, Ontario, nearly half of the population confesses to have smoked a reefer at least once, despite it being illegal. So, just imagine what would happen to demand once all the floodgates are opened.
It’s true that most marijuana stocks are selling for many times their earnings, but there are plenty of examples proving that price multiples cannot always be relied upon.
Take the example of Amazon.com, Inc. (NASDAQ:AMZN). The stock price of this e-commerce behemoth continued to climb while bearish sell-side analysts kept predicting a drop on the grounds of lofty price multiples.
Amazon had a unique moat, leading investors to keep piling into the stock. Many of the top marijuana giants likewise have an edge that may help them survive the industry glut.
For instance, Canopy Growth Corp (OTCMKTS:TWMJF, TSE:WEED) has the highest odds of success because it’s the largest, most ubiquitous, and most renowned player in the game.
Aphria Inc (OTCMKTS:APHQF, TSE:APH), being a low-cost producer and the only major marijuana company boasting positive cash flows, stands the best chance at weathering the pressure of shrinking margins.
Similarly, MedReleaf Corp (OTCMKTS:MEDFF, TSE:LEAF), one of the top choices of medical marijuana patients, may continue to dominate the medical niche, even if the market for recreational marijuana were to fail.
So it’s unfair to paint all marijuana stocks with the same brush.
While the Barron’s story about the marijuana industry identifies some major concerns, it fails to take a holistic view. Canadian marijuana growers are on top of their game and show potential for global growth.
Plus, not every marijuana stock can be weighed on the same scale. At least some of the top Canadian cannabis stocks have the ability to withstand possible upheavals in the industry. So don’t fall prey to this pessimism.