Mar 26, 2014 How High?

by 5i Research

 

Ryan ModestoThe recent legalization of marijuana in some U.S. states, along with the commercialization of medical marijuana in Canada has led to a frenzy where any investment with even a vague reference to the substance has led to some impressive returns. So impressive, that we are finding it difficult to not see parallels between the marijuana industry and the dot-com boom. The Industry is indeed new and interesting as investors are excited to get in on the ground floor. It is a product that is in high demand, so much so, that people are literally willing to break the law to get their hands on it. Rand Corporation estimates the marijuana industry to be close to a $40 billion industry. So before investors get dollar signs in their eyes so big that they cannot see past them, we thought it could be helpful to outline some similarities with the dot-com bubble:

Names:

Similar to the Internet bubble where anything with a ‘hyper’, ‘tech’ or ‘com’ in the name garnered an exorbitant valuation, we are seeing the same trend today. Altitude Organic Corporation with the ticker ‘ERBB’ or Hemp Inc. or even Canada’s own Tweed Inc. are all great examples. This is not to mention the numerous other companies that are coupling scientific sounding words with some sort of marijuana descriptor (green, grow, etc.).

Volatility:

Marijuana stocks have been extremely volatile, trading primarily on sentiment opposed to any fundamentals. Medbox, for example, has a 52 week range of $8.11 to $93.50 and currently sits at around $30. CannaVEST has swung from a low of $10.01 to a high of $201 (no, we did not forget a decimal) and is currently sitting around the $68 range. Finally, GW Pharmaceuticals has skyrocketed from GBP39.39 to GBP422 over the last 52 weeks and is currently GBP338.75.

Dude, where’s my profit?

While there are some legitimate operations generating revenues and profits, there are just as many (if not more) companies that are losing money and some that are not even generating revenue. Even with unprofitable operations, share prices have seen spikes of 100%, 200% and some even in the thousand percent ranges. This sort of unhinging of fundamentals from share prices is a stark reminder of the dot-com era and the pain that can ensue if you are the unlucky one to get in at the top.

Shifting Strategies:

Of all the comparisons mentioned so far, seeing companies change direction or strategy as a means to get at least a toe dipped into the marijuana industry is probably the biggest warning sign that we have seen. Creative Edge Nutrition is a great example as they are a sports nutrition and health supplement company that has moved into marijuana growth operations and enjoyed a 1,733% share price jump which appears simply due to an association with this industry opposed to any actual revenues.

Even with all of the similarities to the Internet bubble, this industry has a lot more headwinds than the Internet did when it was first starting out. Companies did not have to deal with the various regulatory, legal and moral/cultural issues that marijuana companies are bound to face and that investors seem to simply be ignoring.

If investors are still not convinced about the risk and need to get some exposure to the industry there are a few tips we feel could save a lot of potential losses:

  1. Stay away from the pink sheet/over-the-counter markets – This will severely limit your options but also protect an investor from companies with less stringent reporting and a market that can be illiquid and likely more prone to manipulation.
  2. Look for the companies that are at the very least generating revenues with productive assets and preferably have profits.
  3. Consider cigarette companies – We would be very surprised if the large cigarette companies were not interested in this potential and would almost view it as an option on the marijuana industry. These companies have the appropriate distribution and potential to scale operations if the marijuana industry develops in the way that many are hoping it will.

While we don’t know how high this trend can get before it comes back down to earth, we think that we have seen this play out before and it didn’t end well for most. For investors who need to be involved, eyes should be open to the risks and the understanding that while there are and will be some legitimate companies that emerge, a high proportion of them are speculative gambles and not investments. 

Ryan Modesto, 

5iresearch.ca

 

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