Cannabis Investing in 2018 – Our View

by | Jan 2, 2018 | Capital Markets, General, Our Perspectives | 0 comments

January 2, 2018 – Looking back at cannabis stocks in 2017, the only theme that makes sense is “FOMA” (Fear of Missing Out). By mid-December, more than $3.2 billion of capitalization flowed into the cannabis sector, up 191% over the $1.1 billion invested in the same period 2016.

That $3.2 billion translated into 388 transactions (as opposed to 328 in 2016), with an average deal size of $8.3 million (up from $3.4 million in 2016). Of that, $2.6 million (306 transactions) were equity and $574 million (82 transactions) were debt.

The public sector accounted for $2.7 billion raised while private companies raised $533 million.[1]

So what is driving the surge of investment capital flowing into cannabis? We would argue that it isn’t fundamentals. On the other hand, investors are frothy, and the sentiment has been sheer speculation.

Take the Cultivation and Retail segment. We reviewed 21 companies (see table below) to find that in 2017, they ended the year with $18.7 billion in capitalization, with an average increase in valuation of 167% over the year. The combined revenues for the businesses (trailing 12-months) was $193 million. That translates into a surreal price-to-sales ratio for the combined segment of 97.

On an earnings basis, only 2 of the 21 was positive. Combined, the segment lost $193 million for the period. Turning to book value, we found that the segment in review was at about $1.7 billion. On a sector basis, that translates to a P/B ratio of about 10.5. On a company-by-company basis the average P/B ratio was 17.9.

There is no other way to say it. Cannabis stocks are in a bubble – no doubt fueled by the prospects of more states legalizing recreational use and the outlook for growth in terms of users and demand looking incredibly positive. But for investors, this doesn’t mean to be stupidly chasing stocks that are clearly way ahead of themselves further up the ladder.

In our opinion, the money has been taken off the table a long-time ago and at this point, it is all speculation. So our advice is to do your homework, and be patient. If you are in cannabis stocks today, it might not be bad time to take some profit. For those of you that have been on the sidelines, there will be plenty of opportunities to wade into the sector when valuations are more defensible.

[1] Viridian Deal Tracker.