If you're looking at a wall of red in the investing account where you hold your cannabis stocks and wondering whether you've made a series of terrible mistakes, you aren't alone. As a group, marijuana stocks have eaten dirt this year, with the return of the AdvisorShares Pure US Cannabis ETF (MSOS 3.44%) collapsing by more than 50%. Worse yet, with inflation rising and consumers' wallets looking a bit too thin to justify spending money on cannabis, there isn't necessarily any great recovery to look forward to in the near term.
Does that mean it's time to cut your losses and sell your shares? In large part, it depends on how long you're willing to wait.
There's not much relief in sight
At the moment, there are a couple of problems for cannabis companies that make the prospect of selling especially appealing. First, as mentioned before, is inflation leading to crimped demand. Take a look at this chart showing the growth of quarterly revenue for a handful of the industry's leaders:
TCNNF Revenue (Quarterly) data by YCharts.
Only Trulieve Cannabis (TCNNF 4.49%) is continuing to post significantly more sales than it did a year ago. Other major players like Canopy Growth and Aurora Cannabis are actually facing falling revenue. There's no guarantee that this issue is being caused by inflation in isolation, but it's hard to argue that marijuana products are essential goods that people are going to keep buying even when times are getting harder. So, there's likely to be continued top-line pressure for as long as it takes to get inflation under control from its present level.
At the same time, the Federal Reserve is likely to continue raising interest rates to control inflation. For fledgling industries like cannabis, that's bad news, as it means businesses will need to be taking on larger future interest expenses if they want to borrow cash for expansion. And that's not even getting into the adjacent problem of traditional financial institutions in the U.S. being loath to lend to them due to concerns about legal liability. The other fly in the ointment is that it's not exactly a favorable market environment for cannabis cultivators seeking funding to issue new shares, as their stock prices are considerably lower than before.
Finally, the industry's progress toward higher profitability remains quite fragile, and many businesses are actually experiencing falling margins when looking back at the medium term -- which is to say, starting from well before the bear market and the attendant economic issues.
Here's what I mean:
TCNNF Gross Profit Margin data by YCharts.
Once again, while the individual businesses might have plans for how to mitigate their struggles with profitability, they'll be facing some strong headwinds while they implement those plans, and it's hard to imagine stocks rallying significantly until those headwinds abate.
The long-term picture is still rosy
In sum, if you're looking for arguments in favor of selling marijuana stocks, there are a plethora. But, by selling, you'll 100% miss out on your chance to keep building on your positions in the companies you believe can eventually succeed. And right now, marijuana stock valuations are at rock bottom, which means that selling will preclude you from loading up on a bunch of good deals.
Take Trulieve, for example. Despite being the fastest-growing company discussed today, its price to sales (P/S) multiple is near a scant 1.8. That's significantly lower than the P/S ratio of the growth-stock-packed Nasdaq, which is around 4.5. And in the first quarter of 2021, Trulieve's multiple was well above 10. Nothing has fundamentally changed about its core strategy in that time, nor has its business model become significantly less lucrative in the long term.
Even if you're sitting on some gnarly losses, buying shares when valuations are so low will help to dilute the red numbers in your brokerage account, and it's a good decision if you're a believer in the industry as a whole -- and you probably should be. Per a research report by Fortune Business Insights, the market for cannabis will grow with a compound annual growth rate of around 32% between 2021 and 2028, eventually reaching a size of around $197.7 billion annually. With that much growth projected, the troubles of the last couple of years will look like a bump in the road if you're willing to hold your shares for just a few more years. And that's by far the strongest argument in favor of not selling.
