I've been writing about marijuana stocks for over four years, since before the Canadian pot market became fully legal in October 2018. However, given the risks in the sector, I didn't previously have the urge to invest in a cannabis producer. I have invested in hydroponics company Scotts Miracle-Gro as a safe way to gain exposure to the sector, but not ever directly in a company that's involved in the actual growing or selling of marijuana.
That changed last month when I bought shares of Cresco Labs (CRLBF -4.11%), a Chicago-based pot producer. There are three main reasons I decided to finally pull the trigger and invest in the multi-state operator (MSO).
Image source: Getty Images.
1. Marijuana reform in the U.S. is on the horizon
Right now, I believe there's a bit of a sweet spot when it comes to investing in the cannabis industry. It is far enough along that investors don't have to gamble on small companies that may or may not pan out; there are plenty of established producers besides Cresco, including Trulieve Cannabis (TCNNF -3.22%) and Curaleaf Holdings (CURLF -2.69%), to choose from. And at the same time, the industry is still nowhere near its potential given the federal ban on marijuana in the U.S.
Given how quickly pot stocks can take off on positive industry-related news, I didn't want to get caught up in waiting too long, perhaps after a major bill passes and becomes law (e.g. SAFE banking) and stock prices get too high. Although I don't believe marijuana legalization is imminent, there definitely looks to be a path for the sector to benefit from significant reform -- whether it is a change to banking laws or decriminalizing pot. If nothing else, that would offer some proof to investors and industry outsiders that legalization could be coming soon.
And simply decriminalizing pot could be a huge step in getting stocks like Cresco and others onto a major exchange like the Nasdaq or NYSE, and instantly reaching a greater pool of investors. Due to the illegality of pot in the U.S., those exchanges are off limits to MSOs. Instead, they resort to trading over the counter and on the Canadian Securities Exchange, which has looser rules than the larger and more popular Toronto Stock Exchange.
The issue today is that under a more pot-friendly government, Democrats are perhaps trying to do too much at once. Instead of starting small and passing banking legislation, Senate Majority Leader Chuck Schumer is pushing for legalization, which is likely to lengthen the process in achieving significant reform for the sector. But, to me, there's little doubt that reform is coming, and the main questions revolve around which laws will be changed and when those changes will take place.
2. Valuations have been falling
Another reason the time is ripe to invest in cannabis is that pot stocks have been falling out of favor with investors of late. Since there hasn't been much news or progress on legalization, investors have focused on meme stocks or investments that are likely to rise in the short term. These boom-and-bust cycles in the industry are nothing new, unfortunately. When Joe Biden won the U.S. election a year ago, there was euphoria that marijuana legalization might be imminent:
HMMJ Total Return Level data by YCharts
And in the past six months, the bears have come out:
As a bargain hunter at heart, I'm more willing to buy now when prices are lower, especially since I'm confident the pendulum will inevitably swing back in the other direction -- and likely for a much longer duration if reform ends up taking place.
3. Cresco Labs is too attractive a stock to pass up
Even if the timing is right, it's still important to also find a solid stock. And that's where Cresco comes in. It isn't the largest cannabis company out there, but it does plan to get to a run rate of $1 billion in annual revenue by the end of this year, putting it among the industry leaders.
Cresco reported $210 million in revenue in its last quarter (for the period ending June 30), and so for it to get to its annual run rate of $1 billion, its top line would only need to increase its quarterly revenue by $40 million.
Another reason I like Cresco is that it's cheap, trading at a price-to-sales multiple of only 2.5. That's a bargain compared to Trulieve and Curaleaf, which trade at multiples of 4.4 and 6.0, respectively. And its focus on "key markets with appropriate regulations and strong consumer demand" make it more appealing to me than companies that might be too aggressive in their growth. Cresco seems to have struck a solid balance, posting a profit of $2.7 million last quarter (in the prior-year period, it incurred a loss of $41.7 million) while doubling its top line.
Overall, Cresco is one of the safer buys in the sector, and I don't think there's been a more optimal time to invest in cannabis than right now.
