Over the past year, we've seen a pretty big, but important, shift in the marijuana industry. No longer are promises good enough for investors to send cannabis stocks higher. Nowadays, with Canada having legalized adult-use marijuana, and two-thirds of U.S. states giving the green light to medical cannabis, earnings actually matter.

In recent quarters, operating results have been more of a hindrance than help for pot stocks. That's because supply issues in Canada, and high tax rates in the U.S., have constrained sales and pushed most marijuana stocks to a loss. But major Canadian grower Aphria (APHA) aimed to change that perception with its after-the-bell fourth-quarter report on Thursday, Aug. 1.

A clear jar packed with dried cannabis buds that's seated atop a fanned pile of twenty dollar bills.

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Aphria appears to have pulled a rabbit out of its hat

In many respects, Aphria delivered the quarter that cannabis investors have been waiting for. Sales grew to $128.6 million Canadian, or a little over $97 million in U.S. money, representing a sequential quarterly increase of 75%, and a year-over-year improvement of 969%. But before your jaw hits the floor, keep in mind that generally lower-margin European distribution revenue accounted for more than CA$99 million in sales, with net cannabis revenue, after excise taxes, totaling CA$28.6 million. Nevertheless, net cannabis sales rose 85% from the sequential third quarter, with adult-use revenue up 158%. 

What's so surprising about this figure is that Canada has been contending with serious supply issues. Regulatory agency Health Canada has been inundated with licensing applications to review, and there have been compliant packaging solution shortages. The fact that Aphria was able to take such a nice leap forward with its cannabis sales (more specifically adult-use weed revenue) speaks volumes that progress is being made on the supply front in our neighbor to the north.

Aphria also wound up delivering a quarterly profit, which is a surprise given that Wall Street had been forecasting a loss of CA$0.05 per share (about CA$12 million). The company instead recorded net income of CA$15.8 million in the fourth quarter, as well as positive adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization) of CA$0.2 million.

Furthermore, Aphria also provided its outlook for fiscal 2020 (ended May 31, 2020). According to the company, it expects between CA$650 million and CA$700 million in sales, of which a little more than half would come from its distribution operations. This near-tripling in year-over-year sales for fiscal 2020 should result in adjusted EBITDA of between CA$88 million and CA$95 million.

Not surprisingly, Aphria's stock soared in the after-hours session following the release of operating results.

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This figure continues to be a big worry

However, the company's income statement only tells part of the story. A more detailed look at Aphria's balance sheet reveals a figure that should have all shareholders concerned. And no, it's not the company's cash balance, which grew to north of CA$570 million in the fourth quarter, much in part due to a convertible senior note offering of $335 million (about CA$443 million). Aphria remains well-capitalized.

Rather, focus your attention on Aphria's goodwill, which ended the year at nearly CA$670 million, relative to CA$2.44 billion in total assets. Goodwill is simply the amount of premium above and beyond tangible assets that Aphria paid to acquire other businesses. According to Aphria's SEDAR filing, CA$377 million in goodwill is derived from its Nuuvera acquisition, with much of the remainder coming from its Broken Coast purchase (CA$146 million) and its Latin American assets (CA$139 million). As a reminder, Aphria already wrote down CA$50 million of the value of its Latin American assets in the sequential third quarter.

On one hand, some amount of goodwill is expected when acquiring a business. After all, the acquiring company usually has to sweeten the pot (pardon the pun) to entice the other party to accept its offer. But it's not guaranteed that the goodwill Aphria is carrying around can be recouped at a later date. In fact, much of what has been acquired by Aphria has gone straight to goodwill.

John Zamparo, the covering analyst at investment bank CIBC, noted this concern in his firm's recent downgrade of Aphria to "underperform." More specifically, Zamparo believes that the entirety of the goodwill derived from the Nuuvera acquisition could be written down at a future date. This could translate into a nearly CA$1.50 loss per share, as well as wipe out more than 15% of Aphria's total assets.

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Aphria isn't alone

And don't think for a moment that Aphria is alone in carrying around a lot of goodwill.

Aurora Cannabis (ACB -0.69%), the most popular pot stock, and the most-held stock of any company on investing app Robinhood, has piled up the goodwill after making more than a dozen acquisitions in the past three years. According to its latest quarterly report, Aurora Cannabis had CA$3.18 billion in goodwill, which represented 57% of the company's total assets. While some of its goodwill could be recouped by developing the assets it's acquired, it's highly unlikely that the company will offset its entire CA$3.18 billion in goodwill. That makes Aurora a strong candidate for future writedowns, right alongside Aphria.

So, what does this mean for investors? It means that when you're trying to value pot stocks like Aphria and Aurora, you should take into account what they might look like if these writedowns take place. As noted, Aurora would lose more than half of its total assets, while Aphria would lose about a quarter. That certainly alters the view of whether investors are "getting a good deal" with these companies.

In short, be mindful of goodwill, because there's virtually nothing good about it for cannabis stocks.