One of the highest growing industries to invest in is cannabis. Despite a lack of legalization in the U.S., this is an area growth investors should want to target. Fortune Business Insights projects that by 2028, the global market will be worth just under $198 billion, as it grows at an incredible compounded annual growth rate of more than 32%.
The opportunities are massive for investors. Unfortunately, because of the early stages of the industry's growth, there are also considerable risks. If you want to invest in this industry, there are three things you need to know and prepare yourself for.
Image source: Getty Images.
1. Don't expect to see true accounting profits
When cannabis companies report earnings, they usually include adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) numbers. I'm not a fan of using adjusted numbers, but there's merit to doing so when you're looking at cannabis businesses. That's because it's not uncommon to see wild swings in the bottom line due to revaluation gains or impairment charges.
One of the top Canadian marijuana producers, Canopy Growth (CGC -0.66%), recently reported its year-end numbers. Its asset impairment and restructuring charges totaled more than 369 million Canadian dollars over the past year -- that's 71% of its net revenue. Due to so much noise on its financials, it and other cannabis stocks have normally posted losses:
TLRY Net Income (Quarterly) data by YCharts
Although you'll note that Tilray Brands recently posted a profit, that was only due to nonoperating items. It's not impossible for a marijuana company to generate a profit -- you just shouldn't expect it to be the norm from most pot stocks.
2. Be prepared to wait
Many cannabis companies and investors alike are waiting for meaningful reform in the sector. Even just the SAFE Banking Act would be a huge win, making it easy for U.S.-based marijuana companies to do business with the big banks and avoid needing to hold so much cash at their dispensaries. But given the trouble that bill has had in becoming law (it has passed the House six times only to go nowhere afterward), you can be sure that outright marijuana legalization is going to be anything but easy.
The danger investors can sometimes get caught up in is believing the hype. Last year, Canopy Growth CEO David Klein predicted his company would enter the U.S. adult-use marijuana market (which is off-limits until legalization happens) within the calendar year. Not only has that not happened but there's also still no reason to expect that things will change anytime soon.
Patience is important for investors, and it's a pre-requisite if you want to make a decent return from owning pot stocks.
3. Wild swings in price are inevitable
Because of the hype that can sometimes happen around legalization or new marijuana bills, shares of pot stocks can swing wildly. Here's a look at how volatile they are compared to a relatively safe, blue-chip healthcare stock like Johnson & Johnson serving as the baseline:
TLRY 30-Day Rolling Volatility data by YCharts
The above chart looks at the stock's respective standard deviations to calculate volatility. These types of fluctuations can be unnerving to investors who are ill-prepared to be holding pot stocks. In the past year alone, the Horizons Marijuana Life Sciences ETF has cratered more than 60% (the S&P 500, by comparison, has declined by just 1%).
Think you're ready to invest in the sector?
If you're OK with the above caveats, the one thing you should start to do is look at companies that have strong financial positions. Canopy Growth, for instance, has more than CA$1.3 billion in cash and short-term investments on its books, thanks to beer maker Constellation Brands investing billions into the business a few years ago. Although the cannabis producer is burning through cash, the company has strong liquidity that gives it plenty of time to tighten up its business.
By ensuring a cannabis business you're investing in has ample cash on hand, you can help bring down your overall risk. It will also lessen the likelihood that the company will need to raise cash through frequent stock offerings.
