What kind of metrics can investors look for when it comes to the growth of their picks in the cannabis space? Here’s a look at a few key points.
After an investor has decided on a company they wish to invest in, it’s only natural for them to keep an eye on the company and make sure they are delivering on the promise of their business.
Bearing that in mind, if you read the Investing News Network’s (INN) guide on ‘How to Invest in a Cannabis Stock,’ then you know the basics as told to us by analysts on ways to select the best stocks for each investor to put down some cash.
How do you keep track of your stock and what should investors be aware of when they go through the company’s latest announcements, and–more precisely–what kind of metrics can investors look to for the growth of their picks in the cannabis space are some questions that are commonly asked.
For comparison, in the life science sector, investors can look at the performance of a company related to a potential trial they may be conducting and the results of these. Approvals certainly move things along for companies involved with drugs and biotech products. In the cannabis sector, what are the metrics available to investors in this area?
Before we detail what these metrics may look like today, it’s important to understand that–in the grand scheme of things–the cannabis industry is still quite young. Licensed Producers (LPs) in Canada have led the way with business models that have endured and gained recognition with international options becoming more available to them. However, even for them, these metrics aren’t as clear-cut as they may be in other sectors of the trading world.
With that in mind, here INN provides an overview of the key metrics investors should look for after investing in a cannabis stock.
Cannabis stock key metrics: Company revenue and cash flow
Alan Brochstein, a cannabis financial analyst with 420 Investor said the key metrics he evaluates whenever he looks at any cannabis company include revenue, cash flow, liquidity and tangible equity.
He said a lot of companies in the space are actually capable of generating revenue, which in returns gives investors a direct opportunity to have an active role in the growth of this 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 he tracks the operational cash flow, which is the kind of information investors can look for in a company’s public financial sheets, to get a clearer picture in terms of their 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 said.
The rush of the cannabis industry provided many success stories but it also opened the floodgates for companies seeking to make quick gains out of the industry. As such investors should be more aware of the fundamentals of a company especially after they have actually invested in them.
“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.
Cannabis stock key metrics: Is there enough supply?
In a previous interview with INN, Haywood Securities cannabis analyst Neal Gilmer said the majority of LPs in Canada are scaling up as a move to better respond to the expected shortage of cannabis once legalization rolls out next year.
“We’ve seen most of them arrange capital and now it’s time to deploy that capital with respect to capacity expansion. Gilmer said. “Their management teams need to focus on trying to manage the execution risk of completing those capital projects on time and being able to ramp up the capacity of the completed facilities.”
With the upcoming shortage becoming a real possibility, it makes sense for investors to keep an eye on the scale of their stocks and to even make sure there are expansion plans for the future, or already deployed.
“The trend is all about capacity expansion to try to meet the expected demand from the recreational market, it’s been the primary proceeds for any of the financings that we’ve seen out there,” Gilmer said.
Cannabis stock key metrics: EV/EBITDA projections
Russell Stanley, a special situations analyst with Echelon Wealth Partners focused on the Canadian cannabis market, said in an interview with INN that the most practical method he employs to evaluate the companies he covers and the cannabis market is EV (enterprise value), EBITDA (earnings before interest, tax, depreciation, and amortization) expectations and valuation multiples.
EV stands for the value of an outstanding stock plus the net amount of debt the company has in place. “The idea behind EBITDA is that you’re measuring the profitability of a company’s operations before cost related to financing or capital expenditure,” Stanley explained.
According to Stanley, most cannabis companies are not EBITDA positive yet. However, he expects this situation to improve thanks to the upcoming legalization of recreational cannabis in Canada.
“We focus on our expectations for calendar 2019 from a time-basis, and then we look at primarily our EBITDA expectations for that period and compare it them against multiples for the group,” Stanley said.
But why do the EV and EBITDA play such a vital role in the work Stanley does? Because as Stanley explained other metrics aren’t as reliable. He added that the problem with other traditional metrics–like price-earnings–represent an unbalance since companies usually have non-cash gains and charges on a quarterly basis.
“Adjusted EBITDA ideally should neutralize the impact of that… from an investor perspective we think EBITDA multiples are probably the most important metric to look at this point,” Stanley said.
He continued, stating that mergers and acquisitions are about to take a more prevalent role in the industry and, through those companies, decide on these transactions based on what EBITDA multiple they would be paying.
Cannabis stock key metrics: Company production and growth
A major point for investors to determine the success of their cannabis stock is the production and growth capabilities of the company. Simply put: are they producing?
Investors should be aware of a company’s announcements and their ability to deliver on those. When looking specifically at expansion, the size of it and the details of its final production are vital for investors to know.
When asked about the production numbers investors should keep in mind when comparing cannabis companies, Stanley said there are three numbers available:
- Currently licensed capacity: “I don’t think that is really a relevant focus for investors at this point because the expectation is that these companies are going to grow.”
- The capacity number that they are fully financed for: “We call that a funding capacity and that’s an important metric… from evaluation perspective we think the most relevant metric to look at is funded capacity, how much production capacity can a company build out with its current balance sheet.”
- Potential capacity: “[These are] interesting numbers to look at but in many cases, the companies would need to obtain additional financing in order to really realize that potential capacity.”
Cannabis stock key metrics: International agenda
Investors should be aware of what are the options available to them when it comes to potential expansions and partnerships in the international markets available. A big target for anyone interested in cannabis right now 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. Despite the federal status of the drug, on a state level, several ones have adopted cannabis and legalized its medical and recreational consumption.
This disparity in the law allows companies in legal states to grow cannabis and operate related businesses. For Canadian companies, more specifically growers, the US market is off limits in terms of exports. Recently the TMX Group–which is in charge of the Toronto Stock Exchange and the TSX Venture Exchange–issued a statement regarding the need to clarify the stance of Canadian producers with US interests.
Australia and Germany are two other options when it comes to international venues, where laws seem to be moving favorably for experienced LPs looking to make gains from the cannabis adopting population. PI Financial Corp. analyst Jason Zandberg told VICE Money the opportunity of the German market could be “more than double that of Canada.”
A truly open and available international cannabis market will take plenty of time to get there, however, the experience Canadian marijuana companies have gained will allow them to be at the forefront of new opening markets if they so 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 key metrics: In summary
Stanley said that earlier this year he noticed the EV/EBITDA for cannabis companies was significantly higher than what it is now, which in his opinion is a rationalization for the expectations of these companies from investors.
“Most companies are now trading within a far narrower band of multiples which I think is a healthy sign that investors are paying more attention to valuation than they perhaps were doing at the beginning of this year,” Stanley said.
There is excitement and high expectations for the 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 the tried and true business metrics are the best bet as of now for determining the success of the companies they have invested in.
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Securities Disclosure: I, Bryan Mc Govern, hold no direct investment interest in any company mentioned in this article.