You might be surprised that Cronos Group (CRON 0.41%) is the best-performing marijuana stock of all time. It's also one of the biggest winners among healthcare stocks of the 21st century -- at least so far.
But what do those accolades mean when it comes to deciding whether or not to buy Cronos Group stock now? Very little. Cronos Group's previous success doesn't necessarily translate to future returns. Here's what you need to know to determine if this leading marijuana stock is one that you should consider buying.
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The best question to ask
One of the best nonfiction books that I've read is, Decisive: How to Make Better Choices in Life and Work, by Chip and Dan Heath. The Heath brothers detail a great approach to making decisions.
A key component of this approach is to reality-check your assumptions. There's a key question that the authors suggest asking with any big decision in order to do this: "What would have to be true for this option to be the right answer?"
I think applying this question to a decision about whether or not to buy Cronos Group stock is a great idea. Let's try to answer it.
What would have to be true for buying Cronos to be a smart move?
Different investors might list different assumptions to answer this question. However, I suspect that most would include some version of the following assumptions:
- The global marijuana market will expand rapidly.
- Cronos Group will capture enough market share to justify market-beating growth.
There's no question that the global marijuana market already has expanded significantly. But just how big can it grow over the next few years?
Many people start with the size of the current illegal marijuana market. The United Nations estimates the global marijuana market is in the ballpark of $150 billion, including illegal sales of the drug. But for our No. 1 assumption to be true, a lot of countries must legalize marijuana.
There's some solid momentum with the legalization of medical marijuana throughout the world. Major countries, notably including Germany and the United Kingdom, have done so. So far, though, only two countries have legalized recreational marijuana at the national level -- Canada and Uruguay. Mexico might not be too far behind in legalizing recreational marijuana, thanks to the country's Supreme Court overturning a ban on the drug.
The 800-pound gorilla in the room is the U.S. Thirty-two states have legalized medical marijuana, and 11 states allow the legal use of recreational marijuana. More could be on the way. But marijuana remains illegal at the federal level in the U.S.
What level of sales would Cronos need to justify market-beating growth? The company's market cap currently stands at around $1.5 billion. To have a price-to-sales ratio of 4, which is close to the average for alcoholic beverages -- an arguably similar industry -- Cronos would need to generate annual sales of around $375 million. For the stock to grow significantly, the company's sales would need to be even higher.
Two criteria are key for Cronos to achieve this level of sales. First, the company must have ample production capacity. Second, it has to have significant distribution channels.
Cronos is on track to be able to produce 117,000 kilograms of cannabis per year. That should be enough to satisfy the first criteria. The company also secured supply agreements for the recreational marijuana market in four provinces, plus a big supply agreement with Cura Cannabis Solutions. In addition, Cronos has supply deals in Germany and Poland, as well as a key partnership in Latin America.
We can't leave out the potential for Cronos Group's partnership with Ginkgo Bioworks to pay off. The companies are working together to produce cultured high-purity cannabinoids from engineered strains of yeast. If successful, this could greatly reduce the cost of producing cannabinoids and generate even more growth for Cronos.
Playing devil's advocate
What would need to occur to make staying away from Cronos stock the better choice? Either of our key assumptions above would have to prove to be incorrect, and it's not hard to envision ways that could happen.
Global medical marijuana sales, for example, could increase much more slowly than anyone expects, or the U.S. could keep current federal anti-marijuana laws in place. That would prevent Cronos Group from establishing operations in the country because of listing requirements on the Toronto Stock Exchange and the Nasdaq stock exchange.
Canada's recreational marijuana market also could be less lucrative than many expect. The country could take a longer time to finalize regulations for cannabis edibles products, which would delay a highly anticipated market.
Even if the global marijuana market expands nicely, Cronos Group could stumble. The company has rivals with deeper pockets and has a long line of smaller competitors angling to grab a greater share of the market.
On top of all of this, Cronos Group's efforts with Ginkgo Bioworks could flop. Or others scrambling to market similar technology could gain a competitive advantage.
To buy or not to buy?
The only way to decide whether or not Cronos Group is actually a stock to buy is to determine the likelihood that the two assumptions discussed earlier will prove to be correct. And there's a lot of guessing involved in that determination.
My best guess is that the global marijuana market indeed will grow rapidly enough, with Cronos capturing enough market share to enable the stock to deliver market-beating returns. The big caveat to this, though, is that this guess only applies over the long term -- perhaps 10 years or more.
For many investors, there's simply too much guesswork and too much volatility to make Cronos Group an attractive pick. Others with a stomach to handle big swings and the patience to hold for the long run could find Cronos much more appealing.
In my view, Cronos Group stock is one that you could buy, depending on what kind of investor you are. There's another question, however, to keep in mind: Are there even better stocks to buy?
To use the dreaded double negative, I don't dislike Cronos. But I also think there are other stocks that provide better risk-reward propositions.
