For the past couple of years, the marijuana industry has been budding before our eyes. However, the legal pot industry really took shape in 2018, with the passing of the Cannabis Act in our neighbor to the north. Beginning Oct. 17, 2018, recreational marijuana became legal for purchase by adults throughout Canada, ending nine decades of adult-use prohibition. When the industry is running on all cylinders within a few years, it could be generating more than $5 billion in added annual sales.

The prospect of rapid growth is what's helped push most marijuana stocks into the stratosphere. In fact, quite a few have risen in excess of 1,500% just since the beginning of 2016.

A dollar sign shadow cast on a large pile of cannabis leaves.

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Tilray's third-quarter report won't have investors seeing green

Of course, in recent months all eyes have been on bottle-rocket Tilray (TLRY). British Columbia-based medical cannabis grower Tilray made history in late July by becoming the first pot stock to go the initial public offering route on a major U.S. exchange. Since listing its shares at $17, the stock rallied to peak on an intraday basis in mid-September at exactly $300 a share, briefly hitting a $28 billion valuation. Since then, the company's market cap has settled around $10 billion, making it either the largest or second-largest marijuana stock by market cap, depending on the day and how volatile these stocks have been.

The big question (other than "Are marijuana stocks in a bubble?") has been: "Is Tilray really worth $10 billion?" Following the company's release of its third-quarter operating results, we can pretty safely determine that the answer is a resounding "no."

For the quarter, Tilray recorded $10.05 million in sales, representing an 85.8% increase from the year-ago quarter. This improvement in sales was driven by a more-than-doubling in the total kilograms sold to 1,613 kilos from 684 kilos in Q3 2017. The quarterly operating press release also highlights the fact that the company has signed supply agreements for recreational cannabis with eight Canadian provinces and territories. 

But look beyond the bullet-point headlines and you'll see plenty of things that should be concerning for a pot stock valued at $10 billion. In no particular order, here are some of the biggest red flags.

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Tilray is losing a lot of money (and will continue to do so)

Let's begin with the elephant in the room: Tilray's loss ballooned in the third quarter from the year-ago period. The headline figure was a net loss of $18.7 million, or $0.20 per share, up from a net loss of $1.8 million, or $0.02 per share, in Q3 2017.

But I'm far more interested in excluding a number of one-time costs and benefits. In particular, Tilray reported a gross profit of $3.1 million, which was only negligibly higher (about $0.1 million) from the prior-year quarter. Comparatively, stock-based compensation soared to $11.2 million from $35,000 (that's thirty-five thousand dollars) year over year, and both general and administrative and marketing and sales expenses more than doubled. On an operating basis, the company lost $20 million. Yuck!

With Tilray needing to lay the groundwork to expand internationally, build up its product portfolio and brands, and grow its domestic production capacity, these operating losses are probably going to remain high, or swell further, for many future quarters. Through Q3 2018, its accumulated deficit (i.e., adding up all of its net losses since inception) hit $77.2 million.

Flowering cannabis plants up close, with a dark background.

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Production isn't anywhere near top-tier

Next, let's talk a little bit about production. To be perfectly clear, legalization occurred in Canada after Tilray's fiscal third-quarter ended, so we wouldn't expect to see much (if any) impact in the company's reported results. However, this doesn't excuse the fact that it sold a meager 1,613 kilograms in Q3, or around 6,450 kilos on an extrapolated annual basis. On a sequential quarterly basis, Tilray sold only 99 kilos more than in Q2 2018. That's not exactly encouraging from a production perspective. 

It's worth noting that President and CEO Brendan Kennedy said the following in the company's quarterly press release:

The cannabis industry remains very robust and we are pleased with our revenue momentum and strategic achievements in the third quarter. We are in the early stages of achieving our growth potential and our team continues to strategically execute on disciplined operational initiatives and investments to support Tilray's long-term, sustainable growth as the pace of legalization continues to accelerate around the world.

Take special note of Kennedy's assertion that Tilray is "in the early stages." While it could very well become a top-tier producer, it's nowhere near that at the moment.

A cannabis leaf lying atop a neat stack of hundred dollar bills.

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Cannabis prices are already falling

Considering that most Canadian provinces have struggled to meet demand in the early going of the recreational market, and taking into account the size of the medical market on a global scale (Tilray is an active exporter), the assumption would be that per-gram dried flower pricing is strong. But that wasn't the case in Tilray's Q3 report.

The company recorded an average net selling price of $6.21 per gram in the third quarter, down significantly from $7.53 per gram in Q3 2017. Tilray's press release blamed the drop on an increase in year-over-year bulk sales. It's worth adding that the company also saw a decline on a sequential basis from $6.38 per gram in Q2 2018 to the noted $6.21.

One of the biggest long-term concerns for investors is that dried flower will be commoditized over time, pressuring the operating margins of growers that are reliant on dried product. Though it's way too early to make the call of whether or not we're already seeing those pricing pressures, this isn't exactly a great sign from Tilray.

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Tilray is going through its cash at a very quick rate

To be upfront and clear, Tilray is well capitalized. It ended the most recent quarter with $104.2 million in cash and cash equivalents, which includes the $176.1 million it received in proceeds from its initial public offering in July. Subsequent to the end of the quarter, it also priced senior convertible notes due in 2023 in the amount of $475 million. It has plenty of capital at the moment to push its growth strategy forward.

However, this doesn't mean Tilray isn't going to burn through cash at an incredible rate. Through the first nine months of 2018, it's used more than $26 million in operating activities, lost $36.7 million, and purchased more than $38 million worth of property, plant and equipment. Being in the early stages of its capacity and international expansion, Tilray is probably going to burn through a lot of its existing cash in the years to come.

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Dilution is going to be a problem

When Tilray went public in July via an IPO, it raised the noted $176.1 million in cash, reducing fears that it would follow the path of other pot stocks with regard to diluting existing investors with share issuances to raise capital. Unfortunately, Tilray is following a similar path.

Having divvied out almost $17 million in stock-based compensation, Tilray's outstanding share count has grown from 75 million to 93.1 million on a year-over-year basis. More importantly, its $475 million note is convertible. This means noteholders have the option of converting their debt into common stock in the future, which could further add to Tilray's share count. And, as a reminder, more shares outstanding can weigh on the share price of a stock, as well as make it that much harder for a company to generate a meaningful per-share profit.

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One more thing: The lock-up period is right around the corner

Lastly, something that wasn't mentioned in Tilray's quarterly report but is absolutely worth paying attention to is the fact that its 180-day lock-up period ends on Jan. 15, 2019. The lock-up period is a contractual obligation that disallows insiders from selling any of their shares of stock. When Jan. 15 rolls around, and following a major surge in Tilray's stock, it's likely that we're going to see insiders locking in some gains.

The bottom line is that Tilray's management team has the right strategy in looking internationally and focusing on higher-margin medical patients. Unfortunately, investors aren't using the information provided to them very effectively and have been buying into this stock based on emotion rather than logic. In my opinion, there's simply no way even the most optimistic investor can extrapolate a $10 billion market cap out of Tilray given the existing data we have and the outlook for the company.