What kind of metrics can investors look at when it comes to investing in marijuana? Experts share a few key points.
So, you’ve taken the plunge by investing in marijuana stocks. Now what?
After adding marijuana stocks to your portfolio, it’s important for to make sure these cannabis companies are delivering shareholder value.
If you’ve read the Investing News Network’s (INN) guide on ways to invest in cannabis, then you know the basics on how to select the best publicly traded companies.
But after investing in marijuana companies, some questions that are commonly asked are: How do you keep track of marijuana stocks? What should investors be aware of when they go through a company’s latest news? And what kind of marijuana stock metrics can investors look to when tracking their picks?
Since the legal cannabis market offers a blend of different types of companies, there isn’t a clear industry to compare it to. For example, in the life science sector, investors can look at the results of clinical trials; approvals certainly move things along for companies involved with drugs and biotech products.
In the marijuana sector, what are the metrics available to investors? Before detailing what these metrics may look like today, it’s important to understand that in the grand scheme of things the legal cannabis industry is still quite young and carries an inherent risk.
Licensed producers (LPs) in Canada lead the way with business models that have endured, gained recognition and granted these firms considerable market capitalizations; however, even for these marijuana growers, metrics aren’t as clear cut as they are in other sectors.
With that in mind, here INN provides an overview of the key metrics investors should look at after investing in a cannabis stock.
Marijuana stock metrics: Look at revenue and cash flow
Alan Brochstein, a cannabis financial analyst with 420 Investor, has said the key metrics he uses to evaluate any cannabis company are revenue, cashflow, liquidity and tangible equity.
He believes a lot of companies in the space are capable of generating revenue, which in return gives investors a direct opportunity to have an active role in the growth of the industry.
“The level of revenue, as well as the growth rate, are important criteria to track,” Brochstein told INN in an email. “Additionally, it’s a good idea to adjust for revenue acquired through acquisition, as this can overstate the growth rate of the underlying business.”
Brochstein continued, stating that he tracks operational cashflow, which is information investors can look for in a company’s public financial sheets, to get a clearer picture of resources compared to cash.
“If a company doesn’t have sufficient cash, it will need to raise cash, which can put pressure on the stock price,” Brochstein explained.
The rush of the cannabis industry provided many success stories, but it also opened the floodgates for companies seeking to make quick gains. As such, investors should be more aware of the fundamentals of a company, especially after investing. “Many of the companies in the public cannabis space have little or no tangible equity, which can make raising additional capital even more challenging,” Brochstein said.
CIBC Capital Markets analyst John Zamparo also leans heavily on balance sheets, cash burn rates and available liquidity in his cannabis stock evaluations. This strategy is especially important when the market environment is proving challenging for raising capital, such as in recent years.
“We believe focus among cannabis investors has shifted to minimizing downside; in other words, evaluating cannabis stocks from a liquidation perspective, simply comparing market capitalization to net cash balances,” Zamparo wrote in a note to investors in early 2020.
He further stressed attention to “a hyper-focus on balance sheet strength” to help mitigate risks in the long run against potential downturns in the cannabis space.
Marijuana stock metrics: EV and EBITDA projections
Russell Stanley, a special situations analyst with Echelon Wealth Partners focused on the Canadian cannabis market, told INN that the most practical methods he employs to assess cannabis companies are valuations using multiples, as well as enterprise value (EV) and earnings before interest, tax, depreciation and amortization (EBITDA) expectations.
EV represents the value of an outstanding stock plus the net amount of debt the company has in place. To explain EBITDA, Stanley said, “The idea behind EBITDA is that you’re measuring the profitability of a company’s operations before costs related to financing or capital expenditure.”
But why do the EV and EBITDA play such a vital role in the work Stanley does? As Stanley explained, other metrics aren’t as reliable. He added that the problem with someOTCQX:ALEAF traditional metrics — such as the price-to-earnings ratio — is that they represent an unbalance, as companies usually have non-cash gains and charges on a quarterly basis.
“Adjusted EBITDA ideally should neutralize the impact of that … We think EBITDA multiples are probably the most important metric to look at at this point,” Stanley said.
In a cannabis report focused on Q2 2020, CIBC’s Zamparo advised investors to watch for EBITDA developments in the cannabis sector going forward. “We deem it extremely unlikely that the industry’s producers will meet consolidated consensus EBITDA estimates next year, but we expect a greater number of EBITDA-positive business a year from now,” he stated in his report.
Marijuana stock metrics: Production and growth numbers
A major point for investors to determine the success of their cannabis stock is the company’s production and growth capabilities. Simply put: Is it producing?
Investors should be aware of a company’s announcements and its ability to deliver on them. When looking specifically at expansion, the size and details of final production are vital for investors to know.
When asked about which production numbers investors should keep in mind when comparing cannabis companies, Stanley said there are three numbers available, including currently licensed capacity, funding capacity and potential capacity. Of these, he believes funding capacity — how much production capacity a company can build out with its current balance sheet — is the most important of these metrics.
Sales is another area for investors to focus on, especially as the market matures into a challenging environment for growth and capital raises. Nawan Butt, portfolio manager with Purpose Investments, told INN that in the Canadian marijuana sector, investor attention has shifted to the sales performance of public cannabis producers.
In reference to the economic pressure the COVID-19 pandemic is placing on these companies, Butt said strong balance sheets and cashflow will be the deciding factor for survival. “For these producers, the current year or the second half of the year really depends on getting to profitability, and getting to profitability is going to be a large battle in the deep-value space,” Butt said.
Marijuana stock metrics: What is the company’s international agenda?
Investors should be aware of potential expansions and partnerships in international cannabis markets.
A big target for anyone interested in cannabis is the US; however, the situation in the country is confusing at best. On a federal level, cannabis as a whole, including businesses related to it, is illegal. But despite the federal status of the drug, several states have adopted cannabis and legalized its medical and recreational consumption.
This disparity allows companies in legal states to grow cannabis and operate related businesses. But for Canadian companies, more specifically growers, the US market is off limits in terms of exports. In 2017, TMX Group (TSX:X), which oversees the Toronto Stock Exchange and the TSX Venture Exchange, issued a statement to clarify the stance of Canadian producers with US interests.
Australia and Germany are two other options when it comes to international venues, and laws seem to be moving favorably for experienced LPs looking to make gains. PI Financial analyst Jason Zandberg told VICE Money that the opportunity of the German market could be “more than double that of Canada.”
A truly open and available international cannabis market will take time to achieve, but the experience Canadian marijuana companies have gained may allow them to be at the forefront of new opening markets if they choose to enter them.
“It’s a lot easier to increase your exports into a market where you’re already selling. If investors … really want that to be a part of their investment exposure, they should focus on companies that are already exploring the market rather than companies that are still talking about it as an objective, but haven’t actually broken through yet,” Stanley said when asked how investors should evaluate a company’s intentions on an international scale.
Cannabis stock analysis and research firm Technical420 sees the international cannabis market as a great arena for growth in the industry. “When it comes to the cannabis sector, we have a strong conviction level as to the growth prospects that are associated with the international opportunity. We believe that the international market will prove to be a major catalyst for the companies that are levered to it and have been highly focused on this vertical,” states a recent editorial on the platform.
The firm has highlighted Aleafia Health (TSX:AH,OTCQX:ALEAF), Canopy Growth (TSX:WEED,NYSE:CGC) and Aurora Cannabis (TSX:ACB,NYSE:ACB) as three cannabis stocks “that are positioned to capitalize on the global cannabis opportunity.”
Marijuana stock metrics: In summary
There are high expectations for companies in the cannabis market as the industry matures and more standards are set in place. For investors who want to keep an eye on their cannabis stocks, going with tried-and-true business metrics is the best bet as of now for determining company success.
Want more details? Check out these articles for more INNdepth coverage:
Want an overview of investing in cannabis? Check out Why Consider Investing in the Cannabis Industry?
This is an updated version of an article first published by the Investing News Network in 2018.
Don’t forget to follow us @INN_Cannabis for real-time news updates!
Securities Disclosure: I, Melissa Pistilli, hold no direct investment interest in any company mentioned in this article.
Editorial Disclosure: The Investing News Network does not guarantee the accuracy or thoroughness of the information reported in the interviews it conducts. The opinions expressed in these interviews do not reflect the opinions of the Investing News Network and do not constitute investment advice. All readers are encouraged to perform their own due diligence.