If you want to be a discerning investor, you'll need to know what benchmarks matter for the various kinds of stocks you might be interested in purchasing or selling. In the context of pure-play cannabis companies, one of the most important metrics to understand is the cost of cultivating one pound of marijuana.
Per-pound cultivation expenses aren't as easy to analyze as they might seem, though. As it turns out, there's more than one important wrinkle to be aware of, so let's dive in and investigate in more detail so that you'll get a new analytical tool for your cannabis investor's toolkit.
Production costs are the name of the game
Though the exact cost will vary from business to business, the setting where cannabis is cultivated makes a huge impact, as it's much cheaper to grow it outdoors than in greenhouses or fully indoor facilities.
The chart above shows how businesses spend more than twice the amount per pound when they have their growing operation in a warehouse setting than when they grow it in fields. And once you're armed with this information, you also have a benchmark for comparing one company's cultivation costs to the industry median.
If it takes a business less money than the median to foster a pound of marijuana for the growing locations that it uses, that's a preliminary sign that it might be a decent investment.
There's more to picking winners than picking outdoor growers
The trouble with this method is that it's often hard to determine how a company grows the majority of its cannabis.
Thankfully, there's another metric which is useful in understanding cultivation efficiency: The cost of goods sold (COGS). Though COGS doesn't specifically take the growing location into account, it's a great measure for how much it costs a company to get its products into the hands of consumers.
By depicting the COGS as a percentage of quarterly revenue, it's easy to see that Trulieve Cannabis (TCNNF -1.90%) and Cresco Labs probably have more favorable unit economics than Aurora Cannabis. They spend less of their income on cultivating, harvesting, processing, and distributing their marijuana. They also have fatter gross margins, so it's no surprise that their shares tend to perform better over time, too. And all of the above means that Trulieve and Cresco Labs are probably more attractive for investment.
But successful investors make purchases of shares based on their judgments about the future performance of companies rather than their past exploits. Doing this is far easier than it might seem.
For example, when Trulieve recently announced its acquisition of 64,000 square feet of indoor cultivation space in Arizona, we should also be aware that the cannabis produced from there might be on the expensive side. Therefore, in future quarters, we might expect its COGS to slightly rise as a percentage of revenue as a result.
On the other hand, if a few quarters pass and its COGS as a percentage of revenue hasn't budged, we can infer that the cost to produce the marijuana that Trulieve is growing at the new facility isn't significantly different from its norm. And because it's a profitable company, we have another piece of evidence showing that growth in its revenue is indeed favorable for its long-term health. After all, if per-pound production costs keep rising at the same time as sales, it's entirely possible for a business to grow itself into becoming unprofitable.
In closing, be sure to keep an eye on cultivation expenses in comparison to the industry's median, and don't forget to use wider benchmarks like COGS to evaluate cannabis stocks. If you can understand what determines a company's unit economics, you're a long way toward understanding whether it's worth investing in.