Stocks capable of delivering 1,000% returns on capital are exceedingly rare. Fortunately, there are a few traits shared by most of these ultra-high-growth stocks that can help investors spot potential diamonds in the rough.
First off, a massive valuation gap must exist between a company's current share price and its fair value estimate. Under normal circumstances, the market is fairly efficient at pricing equities, but sizable valuation gaps can form when Wall Street has serious doubts about a company's business model.
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Second, and perhaps most importantly, the company must be able to build a solid competitive moat to protect profits over the long-term. Armed with this background, let's consider whether Aurora Cannabis (ACB -4.14%) checks these boxes -- potentially making it a candidate for 10X returns.
Wall Street is convinced an enormous valuation gap exists
Aurora is a top Canadian cannabis cultivator with global aspirations. The company currently sports the largest share of the medical cannabis space in Canada, a growing footprint in Europe with positions in France, Germany, Poland, and the Netherlands, and other various international operations. Since inception, Aurora has placed a heavy emphasis on building out an industry-leading genetics, breeding, and biosynthetics platform.
Its Aurora Coast breeding program in Vancouver Island's Comox Valley, for instance, has successfully developed new cannabis strains with THC levels greater than 28%, along with highly aromatic terpene profiles. That's a big deal, because consumers have consistently shown a preference for high-potency and aromatic dried flower products.
Does a valuation gap exist? Wall Street analysts think Aurora's stock is fairly valued at $4 per share because of its immense scale, unique breeding program, and growing international footprint. Aurora's stock, however, is presently trading at a mere $1.02 at the time of this writing. Put simply, Aurora's stock might have an upside potential of 292% over the next 12 months, which definitely qualifies as a valuation gap.
Longer-term, Aurora's stock may be even more grossly undervalued. Most analysts expect the global cannabis industry to evolve into a $100 billion-plus industry over the next 10 years. Aurora, for its part, would only need to capture 1% to 2% of this sizable market to deliver 10X returns for shareholders. That's not exactly an unreasonable market share forecast for a company with an established business in Canada, a quickly growing international prescence, and a top flight breeding program.
All told, Aurora stock does have a shot at delivering 10X returns for shareholders by 2033.
Aurora lacks this key element
Aurora isn't a slam dunk investment, however. Far from it. The cannabis company's shares have steadily lost value since their public debut, thanks to management's reliance on public offerings to raise capital, an overly aggressive expansion plan, fundamental supply and-demand problems in its home market, the slow pace of legalization globally, among other problems.
Most problematically, though, is the fact that Aurora -- along with every other cannabis company -- doesn't have a straightforward way to build a competitive moat. Brand recognition in the cannabis space is a tough ask due to governmental restrictions on marketing and packaging. Moreover, the confluence of a thriving black market, high excise taxes, high operating costs, and fierce competition from legal entities keep all of these companies from benefiting from economies of scale.
Overall, Aurora won't be able to address the competitive moat issue until the industry has gotten past some of these early growing pains.
What's the verdict?
The bottom line is that Aurora's eye-popping upside potential isn't all that far-fetched. Global cannabis sales are rising by double-digits every year, and the industry is close to a tipping point from a legalization standpoint. To benefit from these powerful tailwinds, though, Aurora will have to figure out a way to survive in this harsh business climate.
On this note, the company recently announced an initiative to convert some of its grow facilities to orchid and vegetable propagation areas, which may help lower its cash burn rate. However, Aurora may have to build out other revenue streams to secure its long-term financing requirements.
Keeping with this theme, competitors like Tilray Brands and SNDL recently jumped into the alcoholic beverage space. Aurora will likely have to find a similar solution to wait out the industry's slow pace of global development. If management can tick this box, however, Aurora's stock could be a bona fide diamond in the rough.
