In a fragile market like the one that exists now, it doesn't take much for shares of a company to crash on bad news. The marijuana sector is especially vulnerable given that there has not been any significant movement in legalizing cannabis in the U.S. over the past year.
One stock that has been struggling badly of late is Scotts Miracle-Gro (SMG +4.70%). Although its business involves more just cannabis, that is a big part of its growth. But unfortunately, that's been an area of weakness since the company provided some disappointing guidance. Despite the troubling news, however, investors shouldn't rush to sell the stock.
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Revenue from its hydroponics business to decline up to 25%
Earlier this month, Scotts' Chief Financial Officer Cory Miller said that its hydroponics segment, Hawthorne Gardening, which helps provide equipment to more efficiently grow crops (including cannabis), could see its sales decline between 15% and 25% this year. This is because there is an oversupply of cannabis in the market, which is hurting demand. The company says the business unit has been struggling with it for "several months."
When the company reported its quarterly earnings in February, sales totaling $566 million were down 24% for the period ending Jan. 1. While both its traditional gardening segment and Hawthorne were down double digits, the latter's 38% decline in sales was more significant (the other segment was down 16%).
The beaten-down stock has been struggling for a while, and now it is half the value of what it was worth just a year ago.
Why investors shouldn't lose hope
It's been discouraging to see this once-hot growth stock plummet in the past year. But a key reason I'm not selling the stock, and why other investors shouldn't get discouraged either, is that the cannabis industry still has a long way to go. While there is an oversupply problem today, that can and will likely change as the industry evolves and gets bigger.
Two of the top markets that recently legalized marijuana for recreational use are New Jersey and New York. However, neither are open for business just yet. The former could be up and running in weeks, but the latter may not be ready until at least the fall, if not later.
Currently, 37 states permit medical marijuana, and 18 have passed legislation allowing recreational use. As more states legalize cannabis, growth opportunities will open up, attracting new producers to the industry. According to Research and Markets, in North America, the legal pot market will be worth more than $38 billion by 2028, expanding at a compounded annual growth rate of 16.6% until then.
Many reasons to buy Scotts today
Despite the bearishness, Scotts could make for an attractive growth stock to invest in. Although sales have been going in the wrong direction of late, there's little doubt that the business will recover. Scotts recently added to Hawthorne's portfolio of products with the acquisition of True Liberty Bags, which provides liners and storage solutions, and lighting company Luxx Lighting. In the big picture, the company is positioning itself for a larger role in the industry's growth, which makes Scotts a promising growth stock to hold.
In addition to the growth prospects, the company also pays an attractive dividend yield of 2.3%, which is about a full point better than the S&P 500 average of 1.3%. Plus, with Scotts trading at its 52-week lows for the year and at a forward price-to-earnings multiple of less than 14 (rival hydroponics company GrowGeneration trades at more than 109 times future profits), investors are getting the stock at a discount right now.
Buying shares of Scotts and holding on for the long haul could be a move you thank yourself for in the future.
