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1 Thing You Should Do Before Buying a Pot Stock

By David Jagielski – Apr 26, 2020 at 6:29AM

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Cannabis investors should add one more thing to their checklist in light of the COVID-19 pandemic.

Investing in cannabis has never been more challenging than it is today. There are many pot stocks to choose from and not all of them carry the same risks. In addition to cash flow and profitability, investors need to consider how much growth to expect from the company as well as the stock's current valuation.

However, as a result of the coronavirus pandemic, there's another item that needs to enter the equation: Where its operations are. Being in the wrong state could prove to be catastrophic.

Cannabis markets to steer clear of

The coronavirus pandemic has forced some states to make difficult decisions, including which businesses are essential and which are not. And that has significant ramifications since being considered essential can be the difference between a company generating enough cash to get by this year and going under.

One state that's not allowing recreational pot shops to stay open is Massachusetts. The reason Gov. Charlie Baker sees a problem with keeping recreational pot shops open is that they could attract out-of-state visitors, which would undermine the state's ability to contain the spread of COVID-19. Baker said, "making those sites available to anybody from the northeast would cut completely against the entire strategy we're trying to pursue." However, medical marijuana dispensaries are still considered essential within the state and are allowed to remain open.

Trimming marijuana plants.

Image source: Getty Images.

Another state that could be problematic for investors is Nevada. While it is permitting the sale of recreational marijuana, the challenge faced by dispensaries is that they may not see many out-of-state visitors, which is likely to hurt sales in a big way. Massachusetts is surrounded by many states that haven't legalized recreational marijuana which can entice cannabis users from neighboring states to visit its pot shops. But the same can't be said of Nevada, where Oregon, Washington, and California all permit recreational pot.

In 2019, Las Vegas brought in more than 42 million tourists, many of them flying in from all over the world. That number will take a big hit this year as a result of significant travel restrictions. For such a tourist-dependent city, it makes cannabis companies based in the area, like Planet 13 Holdings (PLNH.F 2.25%) a much riskier investment.

How can investors minimize their risk?

By gauging where a company does a lot of its business, investors can better assess the risk level of an individual pot stock. And when analyzed in conjunction with its cash balance, rate of cash burn, and prospects for profitability, it can help investors get a complete picture of how strong of a position a company is in to outlast this pandemic. Analysts were already expecting many bankruptcies to happen this year, and COVID-19 may only increase the number of at-risk cannabis companies.

Harvest Health & Recreation (HRVSF) is a multistate cannabis operator, and judging by the states where it has a presence in, it may be one of the safer pot stocks to buy amid the pandemic. The company's largest presence is in Arizona and Florida, both states which have classified marijuana as essential. It also has dispensaries in Arkansas, California, Maryland, North Dakota, and Pennsylvania.

The company released its year-end results on April 7, reporting revenue of $116.8 million for 2019, a 149% increase from the prior-year tally of $47 million. Unfortunately, the company's net loss ballooned from $67.5 million in the previous year up to $173.5 million. By the end of March, the company also had $85 million in cash on its books. The concern for investors is whether that may be enough, as from Dec. 31, 2018, to Dec. 31, 2019, the company's cash and cash equivalents fell from $191.9 million to just $22.7 million. That's nearly $170 million in cash that was used up during the year.

Harvest Health will likely scale back operations this year, but what will be critical to the stock's performance this year is if it can slow its rate of cash burn down enough to avoid having to raise additional cash through the equity markets. Raising cash during a downturn won't be easy, and with Harvest Health's stock already down more than 90% in the past year, investors may ditch the stock for good -- if they haven't already. The stock's performance is even worse than the 69% decline that the Horizons Marijuana Life Sciences ETF has been on over the past 12 months.

Even though Harvest Health may be in good shape in terms of where its operations are, it's still a bit risky when taking into account its cash balance. That's why finding a pot stock that ticks all the right boxes this year will prove to be challenging. But it's important that investors conduct a thorough analysis before investing in a stock; otherwise, they could incur some large losses this year.

David Jagielski has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Planet 13 Holdings Inc. Stock Quote
Planet 13 Holdings Inc.
$1.14 (2.25%) $0.03
Harvest Health & Recreation Inc. Stock Quote
Harvest Health & Recreation Inc.
Horizons Marijuana Life Sciences Index ETF Stock Quote
Horizons Marijuana Life Sciences Index ETF
$4.00 (-11.90%) $0.54

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