In the marijuana industry, there's one financial aspect every investor should always, but always, set high on their list of priorities when evaluating the sector's stocks.
Veteran Fool contributor Eric Volkman reveals the what, and talks about why, in this Motley Fool Live conversation with healthcare and cannabis bureau chief Corinne Cardina recorded on Dec. 22.
Corinne Cardina: What is one tip for cannabis investors going into 2021, what do you think?
Eric Volkman: I think you always want to as an investor, you'll always want to look at how a company is managing its cash.
Cash is a very precious resource in cannabis, and there's just not enough of it. Because cannabis companies constantly make losses, their cash position is always constantly being leeched. So, the more effective management teams are having some success in managing that cash.
You want to look at how cash is draining away, where it's going, are they investing in sensible things that have the potential to pay off, at best, in the mid-term? We were talking about Aurora Cannabis (ACB 4.11%), and their strategy [of] international expansion. They plowed a lot of capital into that for something that's, again I don't think, going to pay off for years and years at best. I think you don't want to be involved with stocks like that.
I think you want to look at companies that might have more modest expectations and ambitions. And if they are scaling up, they're doing it slowly, they're doing it carefully, they're not burning a lot of cash.
As a codicil to that, I would say, you mentioned Aurora and their reverse stock split. Hexo (HEXO 2.35%) did that too, or is in the process of doing that. That's also a red flag, an operation like that, because the reverse stock split in almost every instance -- and definitely in those two instances -- it's basically to save the stock's listing on an exchange.
In Hexo's case it's the New York Stock Exchange, because the New York Stock Exchange requires their stocks to trade -- I think it's like a 30-day trailing, moving average -- above $1 per share. If you have a stock that gets to that level, that's pretty desperate. It's a company that's struggling, it's a company that has done certain things that aren't right.
Look at not only how companies are spending their cash, but how they're managing their shares and how they're managing their finances. Or managing their financing, I should say.
It's been very common, especially this past year, for companies to make secondary share issues. The problem with that, of course, is that, if they do that to any significant degree, it's a heck of a big level of shareholder dilution. Your shares, if you're an investor, [their value] becomes less and less and less... You get less of a percentage of earnings with each share that you hold.
Look at how they're doing financing. It's inevitable, most marijuana companies are going to have to go to the well, either in terms of loans or in terms of share issues, or a combination of the two -- like for example, in convertible shares. But you want to keep an eye on how careful they're being, whether it's haphazard and reckless, whether it's considered and they have like an actual plan for how they're going to deploy that capital.
Yeah, that would be as an investor, as somebody looking at the sector, these factors would be foremost in my mind, and I would recommend that to anybody.