Interest in the marijuana sector is hot. Here experts explain what investors need to know about how to invest in a cannabis stock.
It’s no secret that the marijuana sector is one of the hottest out there right now, with companies rushing to be publicly listed to get in on the action.
Putting it simply, interest in cannabis from both new and sophisticated investors has been heating up over the last couple of years or so. But before any investor makes the decision to buy shares in the cannabis stock market, there are a number of key decisions that need to be made.
The legal cannabis space has opened the doors to many new players in the marijuana stock market looking to expand the investment options available.
The goal of the Investing News Network (INN) is to educate investors and help them make key decisions with respect to their portfolios. To that end, we asked experts in the cannabis industry some of the most important questions to better understand how to invest in a cannabis stock. Here’s what they said.
How to invest in a cannabis stock: Does the company have a license?
One of the most crucial — if not the most crucial — components of any cannabis company is the type of license it may hold or a license it could be applying for in the future.
Following an arduous review process, Canadian companies can qualify to obtain licensed producer status from Health Canada. Companies can produce products for the medical cannabis market or the recreational space.
In order to capture the recreational marijuana market, a producer will need to sign a supply agreement with a province so its cannabis products can find a space on store shelves or online.
Going through the application process with Health Canada is intense, and the government body increased its initial requirements in 2019 when it announced that applicants for marijuana growers will have to own a fully built site that already meets the health agency’s standards.
Health Canada said that after reviewing its licensing process, the government found its resources were being mismanaged and elected to enforce stricter initial standards for producer applicants.
Sean Gercsak, an investment advisor with Canaccord Genuity Group (TSX:CF,OTC Pink:CCORF), said licensed producers in Canada enjoyed impressive gains in share prices during the ramp up to marijuana legalization in October 2018.
According to Mason Brown, a director with Stoic Advisory, licenses are good indicators of where a company may be located in the marijuana supply chain.
The knowledge of what type of license — if any at all — a company holds can paint a clearer picture of where it is heading and if it’s worth investing in.
“Depending on the stage of the licensing process, generating revenue could be anywhere from days to months to years away,” Brown said.
How to invest in a cannabis stock: Does the management team have experience?
Like any other industry, an investor should have a solid awareness of a company’s management team.
For marijuana companies this applies to a special degree given the emergent nature of the space, the quick rise in options of stocks to buy and their market capitalization.
“These are people you’re entrusting your money to, and if you can’t be confident about that, then by all means, don’t invest,” Alan Brochstein, a cannabis financial analyst with 420 Investor, told INN.
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Brochstein suggested the first thing an investor should find out about the people involved in the administration of a marijuana company is their experience in the market and their relationship to the industry.
Brown said two key indicators of an experienced management team are that some of the members have “strong, large-scale greenhouse growing experience” or executive experience from the pharmaceutical world — preferably someone involved with the launch of a blockbuster drug.
“Is management only here to make money, or do they have previous experience on the other side of the table, where cannabis made a material impact on their symptoms?” he said. “Together, these give a strong backing towards management’s passion for the industry and building their company.”
While interest and excitement for the marijuana industry continues to grow, pitfalls are still present in the space for those investing in marijuana stocks.
How to invest in a cannabis stock: What does its capital structure look like?
Brochstein said a quick review of any public company’s financial sheets will provide a lot of information into the model of the company, such as warrants and options.
What’s more, Brown recommended that investors find out how many shares management holds, if they have been buying or selling their own shares and how much capital the founders put into the company.
Brown added that investors should check if there are dilutive securities and what their exercise prices are, as well as the prices and valuations previous financings were done at, if a financing closed recently. He also said investors should know if the shares have a free-trading hold period, as it’s worthwhile knowing when that period ends.
Another important fact to know in terms of capital structure is whether the company is currently facing any debt. This could prove important as the company continues working towards its goals.
Finally, investors might want to ask a company how much it has in cash savings, and how long that will keep the company afloat before it needs to raise more capital.
How to invest in a cannabis stock: What is the company’s strategy and its target markets?
These questions add to the concept of how much room for growth the company still has. As such, investors should be aware of the size of the company, its specific market and where it can go after its initial strategy has completed.
Brown told investors to evaluate the company’s aspirations and how likely it is to achieve those. “Does the company want to be a massive player in a small pond or a small player in a massive pond?”
“If a company is only focused on the medical segment then its total addressable market is going to be smaller than if it wanted to participate in both the medical and recreational markets,” said Brown.
Gercsak approves of investors being speculative and taking a look at cannabis stocks that may have aspirations to enter the recreational market — but only if they have a clear path to permitting and are well defined within the market.
How to invest in a cannabis stock: In summary
As any investor can see, the cannabis market has experienced a tremendous boom; however, there has to eventually be a normalization to the stock prices and valuations of publicly traded companies.
Gercsak said the legal marijuana industry as a whole is in a process of self evaluation as it starts to wonder just exactly how much these stocks are worth.
A research report prepared by Deloitte indicates that the base Canadian market for recreational marijuana could land anywhere in between C$4.9 and C$8.7 billion over the next few years. Estimates for the whole of North America are even larger.
Investors interested in the area are still encouraged to look around by experts like Aaron Salz, founder of Stoic Advisory, who says the unique marijuana industry is growing extremely fast.
“It’s not just a national movement; rather, it’s a global movement, with many large countries enacting regulations that will provide legal access to marijuana to tens of millions of people,” he said.
This is an updated version of an article originally published by the Investing News Network in 2018.
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Securities Disclosure: I, Bryan Mc Govern, hold no direct investment interest in any company mentioned in this article.