Investors across the globe are looking at marijuana stocks, and the resulting flood of investment capital has sent share prices soaring in the sector. Yet as Tilray's (NASDAQ:TLRY) recent experience shows, what goes up to ridiculous heights almost always has to come back down to earth. A lot of hard-hit investors who bought at the top and have seen the share price plunge subsequently feel like they've been unfairly burned.
Yet the risks of marijuana stocks are clear. Even Tilray itself has identified key risk areas that shareholders simply have to take into consideration before buying shares. Below, we'll look at some of the most important risk factors that Tilray has identified for shareholders and what they say about the knowledge you need to be a good investor in the cannabis space.
Straight from the company itself
The best place to start when you're looking at potential risks that a company faces is the company's own regulatory filings. The advantage that U.S. investors have in investing in stocks like Tilray or Canopy Growth (NYSE:CGC) that are listed on well-established U.S. exchanges is that information is available through the U.S. Securities and Exchange Commission.
Yet even for those Canadian companies that haven't yet listed their shares on the New York Stock Exchange or the Nasdaq Stock Market, similar requirements exist under Canadian law. Key documents are therefore available on the Canadian government's System for Electronic Document Analysis and Retrieval, or SEDAR for short.
Tilray's biggest risks
In the S-1 filing that Tilray made with the SEC in preparation for its IPO on the Nasdaq earlier this year, Tilray spent more than 30 pages discussing risk factors that shareholders would face in owning Tilray stock. The risks fell into a few basic categories: cannabis-specific issues, general business risks, challenges related to intellectual property and corporate structure, and risks specific to owning the stock.
Most marijuana investors intuitively understand the potential risks of the cannabis market. Essentially, there's no guarantee that certain potential markets will open to legal cannabis sales, and those that do legalize marijuana might not be as large as anticipated. Many competing marijuana producers will fight for dominance in those markets, and Tilray might not end up being the big winner.
It's also easy to understand some of the other potential growth catalysts for Tilray and its peers and the risks involved there. For instance, finding collaborative partners has been a source of optimism for several well-known marijuana stocks. But as Tilray notes, bringing on a partner necessarily gives up a degree of control over the process of looking at potential avenues for growth in the cannabis market. If the partner can't deliver on its end of the bargain, it could spell disaster even if the marijuana company does everything right.
Tilray predicted its own stock performance
Yet what really shocked some investors was the speed with which Tilray has risen and fallen in its short history as a publicly traded company on U.S. markets. Coming public at $17 per share back in July, Tilray stock soared as high as $300 before falling back below $100 in the span of just a few days.
No shareholder who actually read Tilray's disclosure documents should have been surprised. The company itself made the risks clear in its filing:
The market price for our [stock] may be volatile and subject to wide fluctuations in response to numerous factors, many of which are beyond our control.
Among those factors were some that related to the company's fundamental business prospects, including quarterly financial reports and assessments by professional securities research analysts.
The risks that actually led to Tilray's wild fluctuations in share price stemmed from other warnings:
A significant portion of our total outstanding shares are restricted from immediate resale but may be sold into the market in the near future. This could cause the market price of our stock to drop significantly, even if our business is doing well. Sales of a substantial number of shares of our common stock in the public market could occur at any time. These sales, or the perception in the market that the holders of a large number of shares intend to sell shares, could reduce the market price of our [stock]. [emphasis added]
Like most newly public companies, Tilray released a limited number of shares into the public market at first, and it imposed lock-up provisions on key shareholders to prevent them from selling their stock for a certain period of time. The limited size of the IPO has made it difficult for would-be short-sellers to bet against Tilray's stock, but many short-sellers nevertheless went to great lengths to do so. The limited number of outstanding shares made the subsequent short squeeze especially extreme -- and painful for those who were forced out of their short positions at exactly the worst possible time.
Know the risks
Investors who've lost money on Tilray can't blame the company for their losses, because Tilray did everything it could to list the risks involved in investing in its stock. Whether you're looking at marijuana stocks or any other sector of the market, it's worth the time to see what risks the company you like has identified as important. That way, you won't be taken by surprise if something predictable happens that sends the share price sharply lower.