It's no secret that the marijuana industry is pretty much the hottest thing on Wall Street right now, and with a few small exceptions (e.g., cryptocurrency and blockchain), it's been that way for the better part of three years.

The allure of cannabis is that the market is proven. There are tens of billions of dollars in illicit sales annually around the world, meaning the legalization of marijuana in key markets, as well as implementing a smart tax structure on cannabis in those markets, can potentially move a good portion of these behind-the-scenes sales into legal channels. If that happens, Wall Street's projections of $50 billion to $75 billion in worldwide yearly sales a decade from now seems very doable.

Two rows of dried cannabis buds lying atop neatly arranged hundred dollar bills.

Image source: Getty Images.

Millennials have fallen head over heels for Aurora Cannabis

If the cannabis industry were a popularity contest, Aurora Cannabis (NYSE:ACB) would be at the head of the pack among marijuana stocks. Currently, it's the most-held stock on Robinhood, a popular online investing app with millennials. That means more of Robinhood's 6 million members own shares of Aurora than own shares of Apple, Facebook, or Amazon.com.

What millennials likely appreciate about Aurora Cannabis is its expected domination of the production landscape, and the company's successful push into overseas markets.

At the moment, Aurora has 15 production facilities, most of which are in Canada. Already producing at an annual run-rate of roughly 150,000 kilos per year, the company has forecast an increase to at least 625,000 kilos a year in run-rate by the midpoint of 2020. This assumes that three of its largest cultivation facilities -- Aurora Sun, Aurora Nordic 2, and Exeter -- are fully licensed by then. When operating at full capacity, Aurora could easily top 670,000 kilos or more per year. No other grower, save for Canopy Growth, should even generate half of what Aurora is growing each year.

Aurora Cannabis also has a production, distribution, export, or research presence in 24 countries, which includes Canada. Once again, with the exception of Canopy Growth, no other grower is all that close to Aurora in terms of geographic breadth.

But one thing Aurora does not possess is an easy-to-understand income statement. And to be frank, neither do most pot stocks, for that matter.

A person holding a magnifying glass over a company's balance sheet.

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IFRS accounting and one-time costs/benefits skew most marijuana earnings reports

Canadian-based marijuana stocks report their operating results using International Financial Reporting Standards, or IFRS accounting, which do differ from the generally accepted accounting principles (GAAP) you're likely used to from U.S.-based companies.

Marijuana growers like Aurora are classified by Canada as agricultural growers, which under IFRS accounting creates an odd (but legal) accounting quirk. Aurora, and all of its IFRS-following peers, are required to constantly revalue their marijuana crops to reflect their estimated worth. In other words, a nonflowering cannabis plant is worth less than a flowering cannabis plant, and that needs to be recognized in Aurora's operating results.

Additionally, IFRS accounting requires pot growers to estimate what the cost will be to sell their goods, often many weeks or months before they actually do so. Suffice it to say, these revaluations can cause some wild above-the-line swings in gross profit.

Furthermore, a few of the largest marijuana stocks regularly recognize a number of one-time benefits and reductions that can impact their results. Aurora, for instance, has seen big gains and losses from revaluing its investments each quarter, or changing the nature of how an investment was recognized, as it did with its position in The Green Organic Dutchman. Depending on the underlying volatility in a marijuana stock's share price, warrants may also need to be revalued quarterly, which can impact operating results.

In short, the bottom-line number you see might have a lot of icing on it, and you'll need to scrape away the frosting to get to the cake.

A dollar sign shadow being cash atop a pile of cannabis leaves.

Image source: Getty Images.

A no-frills look at Aurora Cannabis' bottom line

That brings us back to the most popular pot stock in the world, Aurora Cannabis. Let's take a closer look at what its "cake" looks like once you scrape away the frosting.

In Aurora's fiscal third-quarter report, which ended March 31, 2019, it reported $75.24 million Canadian ($56.55 million) in gross sales, and CA$65.15 million in net revenue, after excise taxes were accounted for. Its cost of sales were CA$28.91 million, leading to a gross profit before any fair-value adjustments of CA$36.23 million. This works out to gross profit margin of 55.6% and is an improvement over recent quarters.

You'll note that I've ignored the more than CA$16 million Aurora gained above-the-line as the result of fair-value adjustments and unrealized gains on changes in fair value, because this is an exercise in examining Aurora's gross profit and bottom-line results without accounting frills.

As for expenses, Aurora recorded the following:

  • General and administrative: CA$50.79 million
  • Sales and marketing: CA$16.32 million
  • Acquisition costs: CA$2.18 million
  • Research and development: CA$3.52 million
  • Depreciation and amortization: CA$18.18 million
  • Share-based compensation: CA$39.25 million

As you can see, general and administrative expenses, along with sales and marketing, combine to almost double up the company's gross profit.

An accountant double-checking figures line by line with the aid of a calculator.

Image source: Getty Images.

Additionally, even though share-based compensation isn't necessarily a recurring expense for all publicly traded companies, it pretty much is for Aurora Cannabis, which has financed pretty much every acquisition, and a number of partnerships and investment, with its common stock. That makes this CA$39.25 million in share-based compensation an expense that should very much be considered by investors.

What we're not including in the recurring expense column are Aurora's unrealized gains on marketable securities and derivative investments, and its unrealized losses on derivative liability, along with a host of other one-time costs and benefits.

Removing these one-time costs and benefits leaves us with the cake. In the third quarter, Aurora had a gross profit of CA$36.23 million, operating expenses of CA$130.24 million, and would have reported an operating loss of CA$94.01 million, without fair-value adjustments and other one-time costs/benefits, but including share-based compensation. That's significantly smaller than the CA$160.2 million Aurora lost on a net basis in the fiscal third quarter. This is the figure that investors should really be considering when gauging the health of a pot stock like Aurora.

It's also a great reminder to take bottom-line EPS figures from marijuana stocks with a grain of salt until you've scraped away the frosting.