Cannabis stocks are in the dumps this year, but that doesn't necessarily mean you should avoid the entire industry. Certain types of stocks can make for good investments and be suitable for certain types of investors. Here's a look at which stocks might be worth investing in today.
One metric to focus on
It can be challenging to find good buys in the industry. If you look at a cannabis company's financials, they're often littered with adjusted numbers for profitability, margins, and sometimes even revenue.
What generally doesn't lie, however, is the cash position. And that's arguably the most important one for investors to consider when looking at cannabis stocks. If a business isn't generating positive cash flow from its day-to-day operations, then it really doesn't matter if it's profitable on an adjusted earnings basis before interest, taxes, depreciation, and amortization (EBITDA) basis.
Here's how some of the big names in the cannabis industry stack up with respect to operating cash flow:
Data source: YCharts.
By and large, the one trend is that Canadian-based companies generally struggle to generate positive cash flow. Canopy Growth, which has often been seen as the figurehead for the industry, has a big problem with cash burn, much worse than other top pot stocks.
In the Canadian pot market, there's lots of competition and the market is fully legalized, and there are no potential growth opportunities like there are in the U.S. -- where more states can legalize pot. That means the situation may only get worse for Canadian cannabis businesses.
The picture isn't necessarily all that rosy for cannabis investors south of the border, either, but it's a bit more promising. And that's where growth investors should focus on: multi-state operators (MSOs).
Brace for lower growth rates
Although more states have legalized marijuana in recent years (Maryland opened its doors to adult-use pot in July), growth is not a slam dunk. Curaleaf Holdings is a top MSO and has been scaling down its business and exiting markets in an effort to improve its financial position and cash flow. While it and other MSOs may provide investors with better growth opportunities than their Canadian counterparts, they've been experiencing less growth than before.
Data source: YCharts.
Cannabis isn't proving to be an inflation-resistant industry either. The black market remains a big problem because it can undercut legal pot shops and lure customers away. As long as economic conditions are challenging, investors should expect growth rates within the industry to continue to fall. But if you temper your expectations for pot stocks, they could be worthwhile buys as their prices have been coming down.
Pot stocks are cheap right now
The key reason investors may want to take a chance on marijuana stocks is that their valuations are low right now. Cresco Labs (CRLBF 5.13%), for instance, is trading at a price-to-sales multiple of much less than 1.
Data source: YCharts.
On Monday, Cresco announced it would no longer be pursuing a merger with fellow MSO Columbia Care and that they both agreed to terminate their pending deal. That could, however, be a good move for the respective businesses as they can become leaner at a time when cannabis companies may benefit by being smaller and having more sustainable operations.
But whether it's Cresco or other MSOs, investors can definitely grab some pot stocks at much more attractive valuations than in years past.
Pot stocks can be good buys -- if you're patient
It's a tough time to be a cannabis investor right now and there's no guarantee things will improve anytime soon. But the industry is still growing, with Fortune Business Insights projecting that until 2030, the global pot market will expand at a compounded annual growth rate of 34%.
U.S.-based pot stocks can provide investors with some exceptional value right now, as long as you're not expecting a quick turnaround or for federal marijuana legalization to come soon. But if you're comfortable with waiting at least a few years or more for a recovery, there are multiple pot stocks that could be good buys right now, including Cresco Labs, Curaleaf Holdings, and Green Thumb Industries.
