Earnings season for cannabis stocks has come and gone, but one theme remains: disappointment.

At this time last year, it was believed that marijuana stocks would see enormous sales growth and be on the cusp of profitability as a result. Canada had launched recreational weed sales on Oct. 17, 2018, and a number of U.S. states were pushing toward legalizing medical or recreational cannabis. In other words, everything seemed to be aligned for pot stocks to succeed.

But things haven't gone as planned, which is pretty much the modus operandi of next big thing investments. Canada has dealt with persistent supply problems since day one of legalization more than a year ago, while high tax rates and a Swiss cheese-like licensing process in some U.S. states have made it extremely difficult for cannabis growers to compete with the black market. This weakness has been reflected in poor operating results almost across the board.

An up-close view of a flowering cannabis plant growing in a commercial farm.

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Aurora Cannabis produces a dud in its fiscal first quarter...

A perfect example would be Canadian grower Aurora Cannabis (NYSE:ACB). On Thursday, Nov. 14, after the closing bell, the most popular marijuana stock in the world lifted the hood on its fiscal first-quarter operating results for everyone to see -- and the results weren't pretty.

For the quarter, Aurora wound up generating net sales of $75.2 million Canadian, which works out to a sequential quarterly decline of 24% from the fiscal fourth quarter of 2019. This included a near-halving in the company's wholesale cannabis revenue from Q4 2019, as well as a 33% drop in consumer cannabis sales. What was so notable about this sales drop-off is that Canadian licensed store sales have risen for six consecutive months, according to data published by Statistics Canada, so Aurora's weakness really caught most of Wall Street off guard.

What was expected was another quarter of relatively steep losses, and the company certainly delivered in this respect. Before including a number of one-time benefits and fair-value adjustments, the company totaled CA$42.5 million in gross profit next to CA$131.1 million in operating expenses. Including the benefit from fair-value adjustments, Aurora still lost CA$77.4 million on an operating basis. It doesn't appear to be getting any closer to operating profitability.

Worse yet, things have gotten so dicey in the Canadian cannabis realm that Aurora is among a handful of growers that's begun cutting back on production. In its Q1 2020 report, the company announced the immediate halt of construction at Aurora Sun in Alberta and Aurora Nordic 2 in Denmark. These are facilities that were expected to yield at least 230,000 kilos and 120,000 kilos, respectively, on an annual run-rate basis by mid-2020. Now, just 238,000 square feet of Aurora Sun's 1.62 million square feet will be actively in production. It's fair to say that Aurora projected run-rate output by mid-2020 has probably been halved. 

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...Yet lands an upgrade from Wall Street

Despite all of this, Aurora Cannabis managed to land a Wall Street upgrade following its earnings release.

Cantor Fitzgerald covering analyst Pablo Zuanic, who just initiated coverage on Aurora with a neutral rating and a price target of CA$5.10 ($3.84) less than two weeks before its report, upgraded the company to an overweight rating with a new price target of CA$5.85 ($4.41). Based on Aurora's close one week ago, this represents a near-doubling in the company's valuation. 

According to Zuanic, the upgrade makes sense because he and his company don't see things getting any worse for Aurora than they did in the September quarter. This upgrade is a really a shot in the arm that it's among the best of its peers, especially when it comes to the company's superior gross margin. Aurora did report that its cash cost to produce per gram sold fell by 25% from the sequential quarter to CA$0.85. As the company's existing grow farms continue to come online, economies of scale and above-average growing efficiency should allow Aurora to deliver per-gram production costs that are lower than the industry average.

Zuanic also cued in on Aurora's lack of provisions for rebates and returns in its quarterly report. This compares to Canopy Growth, which recognized a whopping CA$32.7 million in sales adjustments tied to returns, return provisions, and pricing allowances in its fiscal second quarter.

This push away from lower-margin wholesale revenue and toward high-margin derivatives, which will hit dispensary shelves by mid-December, are what lead Cantor Fitzgerald to believe that the bottom is in on Aurora Cannabis.

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

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Cantor Fitzgerald (and everyone else) is overlooking one important balance sheet metric

While I do understand the desire for Wall Street and investors to bottom-fish with a company like Aurora, the issue I have is that they're ignoring a toxic figure on its balance sheet. And no, it's not the company's cash balance, which is arguably too low to support Aurora's previously aggressive expansion tactics in a now stagnant Canadian pot market.

The reason Aurora is likely to find little traction in the near term is the company's enormous goodwill, which totaled CA$3.17 billion in Q1 2020. That's 57% of the company's total assets.

Goodwill is essentially a monetary representation of the premium Aurora paid for its acquisitions above and beyond tangible assets. While recognizing goodwill is fairly common following an acquisition, the amount that Aurora has recognized relative to the actual value of its deals is huge. For instance, its CA$2.64 billion purchase of MedReleaf led to CA$2 billion being recognized as goodwill. In fact, pretty much every purchase Aurora has made has resulted in at least half the value of the deal being recognized as goodwill.

In an ideal scenario, a company lugging around goodwill will build out the infrastructure of acquired assets, as well as monetize any patents and intellectual property, to recoup any and all premium. But given just how grossly it appears that Aurora overpaid for its acquisitions, this probably isn't possible. After all, we've seen two pot deals amended in just the past couple of weeks.

In layman's terms, Aurora Cannabis is a writedown waiting to happen. And the value of that writedown is currently about equal to the company's market cap. Though I fully understand Cantor's optimism, I don't share it. I believe investors would be best served by sticking to the sidelines until Aurora's management team bites the bullet and admits that it grossly overpaid for most, or all, of its acquisitions.