The marijuana sector has experienced highs and lows over the past few years, with some cannabis stocks performing better than others.
Both new and sophisticated investors are interested in the cannabis market — legal marijuana has opened the doors for many new players in the industry looking to expand their investment options.
But before any investor makes the decision to buy shares in the cannabis stock market, there are a number of key decisions that need to be made.
The goal of the Investing News Network (INN) is to educate investors and help them make key decisions with respect to their portfolios. To that end, we asked experts in the cannabis industry some of the most important questions to better understand how to invest in a cannabis stock. Here’s what they said.
How to invest in a cannabis stock: Does the company have a license?
One of the most crucial — if not the most crucial — components of any cannabis company is the type of license it may hold or a license it could be applying for in the future.
Following an arduous review process, Canadian companies can qualify to obtain licensed producer status from Health Canada. Companies can produce products for the medical and recreational spaces.
In order to capture the recreational marijuana market, a producer will need to sign a supply agreement with a province so its cannabis products can find a space on store shelves or online.
Going through the application process with Health Canada is intense, and the government body increased its initial requirements in 2019 when it announced that marijuana grower applicants will have to own a fully built site that already meets the health agency’s standards.
Health Canada said that after reviewing its licensing process, the government found its resources were being mismanaged and elected to enforce stricter initial standards for producer applicants.
Sean Gercsak, an investment advisor with Canaccord Genuity Group (TSX:CF,OTC Pink:CCORF), said licensed producers in Canada enjoyed impressive share price gains during the ramp up to marijuana legalization in October 2018.
According to Mason Brown, a director with Stoic Advisory, licenses are good indicators of where a company may be located in the marijuana supply chain.
The knowledge of what type of license — if any at all — a company holds can paint a clearer picture of where it is heading and if it’s worth investing in.
Invictus MD (TSXV:IMH OTC: IVITF) is a cannabis company which represents a platform of licensed producers, under the Access to Cannabis for Medical Purposes Regulations (“ACMPR”), dedicated to providing high-quality, regulated pharma-grade cannabis for medical and recreational use. Our growers are supported by over 250 acres of buildable property with full access to our team of industry-leading horticulturists, biochemists, and project managers. Successful Realized Return on Investment.
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“Depending on the stage of the licensing process, generating revenue could be anywhere from days to months to years away,” Brown said.
How to invest in a cannabis stock: Does the management team have experience?
Like any other industry, an investor should have a solid awareness of a company’s management team. For marijuana companies, this is especially important given the emergent nature of the space, the quick rise in options of stocks to buy and their market capitalizations.
“These are people you’re entrusting your money to, and if you can’t be confident about that, then by all means, don’t invest,” Alan Brochstein, a cannabis financial analyst with 420 Investor, told INN.
Brochstein suggested the first thing an investor should find out about the people leading a marijuana company is their experience in the market and their relationship to the industry.
For his part, Brown said two key indicators of an experienced management team are that some of the members have “strong, large-scale greenhouse growing experience” or executive experience from the pharmaceutical world — preferably someone involved with the launch of a blockbuster drug.
“Is management only here to make money, or do they have previous experience on the other side of the table, where cannabis made a material impact on their symptoms?” he said. “Together, these give a strong backing towards management’s passion for the industry and building their company.”
As the variety of available cannabis products branches out into other subsectors such as edibles, beverages and wellness products, it’s imperative to have a few team players on the roster that are well versed in these industries inside and outside the marijuana realm.
While interest and excitement for the marijuana industry continues to grow, pitfalls are still present in the space for those investing in marijuana stocks. A strong management team can mitigate investors exposure to such risks.
How to invest in a cannabis stock: What does its capital structure look like?
Brochstein said a quick review of any public company’s financial sheets will provide a lot of information on the company’s model, such as warrants and options.
What’s more, Brown recommended that investors find out how many shares management holds, if they have been buying or selling their own shares and how much capital the founders put into the company.
Brown added that investors should check if there are dilutive securities and what their exercise prices are, as well as the prices and valuations previous financings were done at, if a financing closed recently. He also said investors should know if the shares have a free-trading hold period, as it’s worthwhile knowing when that period ends.
An important fact to know is whether the company is currently facing any debt. This could prove important as the marijuana company continues working towards its goals. Investors might also want to ask a firm how much it has in cash savings, and how long that will keep the company afloat before it needs to raise more capital.
As cannabis companies mature into a world marked by increasing periods of economic upheaval, a strong balance sheet is a must. In the midst of the COVID-19 crisis, Nawan Butt, portfolio manager with Purpose Investments, told INN that in the Canadian marijuana sector in particular, attention is shifting to the sales performance of public cannabis producers.
Butt said in order to evaluate their ability to survive such pressure, he’s been dedicating a lot of attention to the balance sheets of public cannabis companies.
John Zamparo, an analyst with CIBC Capital Markets, appears to agree with this strategy. In a note issued to investors, Zamparo stressed that in times of economic uncertainty, investors should have “a hyper-focus on balance sheet strength,” which he believes helps in the long run to protect against potential downturns in the space.
Being cash flow positive and earnings before interest, tax, depreciation and amortization (EBITDA) positive, or at least on the path there, are in turn positive signals for investors that these companies will have a better chance at accessing capital than their peers.
“Capital has been very challenging for companies lately,” Andrew Udell, a financial expert with the Cannalysts, a popular research group, said to INN. “Companies that have demonstrated earnings and demonstrated EBITDA-positive status are going to be able to access capital.”
How to invest in a cannabis stock: What is the company’s strategy and its target markets?
These questions add to the concept of how much room for growth the company still has. Investors should be aware of the size of the company they are looking at, its specific market and where it can go after its initial strategy has been completed.
Brown told investors to evaluate the company’s aspirations and how likely it is to achieve those. “Does the company want to be a massive player in a small pond or a small player in a massive pond?”
“If a company is only focused on the medical segment then its total addressable market is going to be smaller than if it wanted to participate in both the medical and recreational markets,” said Brown.
Gercsak approves of investors being speculative and taking a look at cannabis stocks that may have aspirations to enter the recreational market — but only if they have a clear path to permitting and are well defined within the market.
How to invest in a cannabis stock: In summary
As any investor can see, the cannabis market has a lot to offer now and in the future. In fact, the North American cannabis market as a whole could grow at a compound annual growth rate of 15.5 percent to reach as much as US$104.9 billion by 2027.
Investors interested in the area are encouraged to look around by experts like Aaron Salz, founder of Stoic Advisory, who said the unique marijuana industry is growing extremely fast.
“It’s not just a national movement; rather, it’s a global movement, with many large countries enacting regulations that will provide legal access to marijuana to tens of millions of people,” he said.
Want more details? Check out these articles for more INNdepth coverage:
Want an overview of investing in cannabis stocks? Check out Why Consider Investing in the Cannabis Industry?
This is an updated version of an article originally published by the Investing News Network in 2018.
Don’t forget to follow us @INN_Cannabis for real-time news updates!
Securities Disclosure: I, Melissa Pistilli, hold no direct investment interest in any company mentioned in this article.