I hate pot.
Growing up in the 1970s, all my friends smoked pot.
I never did. Well, I tried it one time. I took one drag, and that was enough for me.
I couldn’t stop coughing, and the smell made me sick.
I wanted to disclose this information before I shared my thoughts on pot stocks...
Because right now, investors are rushing into pot stocks. They're dreaming of making 20 times their money.
Senators Cory Gardner and Elizabeth Warren have introduced a bill to legalize marijuana at the federal level. Currently, only nine states have made the use of recreational marijuana legal.
Companies are pitching riches beyond investors' wildest dreams. Thoughts of adding pot to candies, soda, and gummies are the path to easy money.1
But before you start dreaming, too, let’s look at this rationally...
The key question that you need to ask is this: Is putting money into pot stocks an investment or a speculation? Your answer to that question will tell you a lot about the type of investor you are.
And here’s why...
Investing Vs. Speculating
More than 80 years ago, Ben Graham, Warren Buffett’s teacher, defined what an investment is.
An investment operation is one which, upon thorough analysis, promises safety of principal and a satisfactory return. Operations not meeting these requirements are speculative.
Pot stocks don’t pass Graham’s definition of an investment.
Sure, you might spend a lot of time doing a thorough analysis on pot. And the returns can be satisfactory and even huge. But they do not promise safety of principal.
And because they don't qualify as an investment, they're a speculation. In other words, putting money into pot stocks is a speculation.
I have no problem if you choose to put your money into a pot stock. But I caution you not to fool yourself into thinking that you're making an investment...
The Value of Pot Stocks
Other than a handful of cannabis stocks turning a profit, most are losing money. And the ones that are making money are trading at sky-high valuations.
Aphria Inc. (APHQF) is Canada’s largest producer of medical and recreational marijuana.
Fear of missing out pushed the stock up to $18 a share, even though the company has only earned $0.16 per share over the past 12 months.
In January 2017, the stock was trading at around $4 per share. There were 111 million shares outstanding.
By September 2017, the stock was still around $4 per share, but pot stocks were hot.
So, Aphria diluted its shares. Now, there were 139 million shares.
Right now, there are 182 million shares outstanding, and the stock is down by more than 50% from the January 2018 high.
As the number of outstanding shares increases, each existing stockholder owns a smaller, or diluted, percentage of the company. This makes each share less valuable.
And one more thing... Over the last 12 months, Aphria Inc. has only earned $0.16 per share. In other words, it’s trading at 56X earnings.
At $9.50 per share, the market cap is $1.7 billion.
As investors piled into the stock, management was only too eager to sell them more stock.
At the end of the day, Aphria grows an agricultural product: marijuana. So, it'll be subjected to all the risks that corn, cotton, and soybean have to deal with. This includes insects and plant diseases. Even though it will be grown indoors "under climate controlled conditions, there can be no assurance that natural elements will not have a material adverse effect on any such future production.”
Investors are willing to buy a $1.7 billion company that only earned $25 million and grows plants indoors.
I’ve seen this movie, and it always ends badly.
Keep in mind that Aphria, Aurora Cannabis Inc. (ACB), and any other Canadian pot stock can't sell their product anywhere in the U.S. Doing so would be illegal.
The competitive advantage of pot stocks is very low. One hedge fund took a short position on Aurora. The stock is currently trading for around $9 per share. The market cap is $5.3 billion. But the company hasn’t made a penny.
The hedge fund said the company could be recreated for about $150 million:
Marijuana Stocks in Comparison
Now, compare Aphria or Aurora to Apple (AAPL).
Apple is ranked as the No. 1 brand in the world. Its brand value alone is worth more than $180 billion!
Unlike Aphria, Apple has been buying back its shares. Over the last five years, Apple has repurchased close to 25% of its outstanding shares.
Share repurchases reduce the number of shares outstanding. With fewer shares outstanding, earnings per share (EPS) increase the value of the remaining shares. Put simply, each share is now more valuable.
Apple earned more than $53 billion over the past 12 months from sales of $247 billion.
Apple’s market cap is more than $910 billion, which is just shy of $1 trillion!
If you deduct the $270 billion in cash and investments, Apple is trading at around 12X earnings.
There's a very low probability of someone suffering a permanent loss of capital when they invest in Apple. But the same can’t be said for Aphria and Aurora.
And that also goes for the majority of cannabis companies that haven’t even made profits, yet...
Questions to Ask Before Buying Pot Stocks
So, before making any investment, I suggest you ask yourself the following questions:
- Did I spend the time doing my analysis? Most investors don’t do anything more than look up the ticker and then go online to buy a few hundred shares. That’s not the way to get rich by investing in stocks. If you're doing that without spending a few hours to learn about the industry and company, you’re bound to lose money.
- Can I suffer a permanent loss of capital? There's a difference between seeing the stock price moving up and down and losing money. Stock fluctuations are part of the game. Stocks move higher and lower over the short term based on noise. Permanent loss of capital is when the company goes belly-up and the stock is worthless. That's what you want to avoid. When making an investment, if there's even a slight chance that you'll lose all your money, you should walk away.
- Does this investment offer me a good return? If you’re going to put your money at risk, you better get paid for it. Putting your money into a high-risk investment only to make a return not much higher than a 10-year Treasury bill yield, which is currently about 3%, is just plain dumb.
If you can’t answer each of these questions, then don’t do anything. Just stand there.
The key to making money over the long term is to make a bunch of smart decisions over the short term.
I’d start with one smart decision right now.
Stick with companies that have a healthy balance sheet and are trading at a bargain price.
In addition to Apple, here are a few of the stocks on my list that I’m watching:
- Fiat Chrysler (FCAU)
- Bed Bath & Beyond (BBBY)
- Signet Jewelers (SIG)
- Micron Technology (MU)
These companies are trading at attractive prices and have strong balance sheets. Over time, I’m willing to bet dollars to donuts that a portfolio of these companies will outperform a portfolio of pot stocks over the next five years...
Speculating on Pot Stocks
The way I see it, cannabis stocks are nothing more than lottery tickets.
I don’t have a problem with you taking some of your hard-earned money to buy lottery tickets. It’s your money, and you can spend it any way you want.
But you shouldn't fool yourself into thinking that you're investing. You’re speculating. And if you're speculating, you should be mentally and financially prepared to lose your money.
All my best,
Founder, Park Avenue Digest
Charles cut his chops on the trading floor of the New York Futures Exchange before he moved on to become a wildly successful money manager on Wall Street.
And with more than 35 years of recommending stocks under his belt, Charles has knocked the cover off the ball. He's compiled an amazing record of success and posted gain after gain for his loyal readers. He's the founder of Park Avenue Investment Club and Insider Alert newsletters.
Charles is also the author of the highly acclaimed book Getting Started in Value Investing.
1 The National Institute on Drug Abuse (NIDA) recently published a study on marijuana. Nationwide trends are not pointing in the right direction for kids 12 years old and up.