Marijuana Investing: Avoid These Common Mistakes Investors Make!

Marijuana Investing

Investors face a myriad of opinions when it comes to marijuana investing. Considering the recreational cannabis market in Canada is still incredibly young, even analysts in the know have to learn as they go.

But one thing is certain: so far, very few industries have shown the returns that marijuana stocks offer. For example, this year alone, a host of marijuana stocks such as HEXO Corp (TSX:HEXO) (NYSE:HEXO), Cresco Labs (CSE:CL) (OTCQX:CRLBF), and OrganiGram Holdings (TSXV:OGI) (NASDAQ:OGI) have already doubled in value.

Because of this, investors are incredibly bullish on the cannabis industry, and it makes sense; global sales are estimated to hit anywhere between $50 billion and $75 billion in the next ten years. This is according to evaluations from several Wall Street analysts watching the space and logging current sales. With that expectation, we are bound to see many cannabis behemoths emerge.

But as with every investment, there are risks and pitfalls to avoid, and marijuana investing is no different. So when opting for that prime stock, here are some key factors to keep in the back of your mind.

1. Marijuana Investing: Market Caps are Often More Important than Stock Price

There's a common misconception out there that a company's share price is a true indicator of the business's core value. However, when choosing stocks to purchase, the market cap should be the key consideration because it will tell you the actual value of the company.

The market cap will give you the fundamental starting point for evaluating which marijuana company should earn your investment. And comparing this company to other similar-sized ones in the industry helps to see the true performance of the one on your radar.

Focusing on market caps instead of share prices gives you an idea of the company’s value within the marketplace—making a wise investment is all about context.

So while a $2 share price is initially more appealing, a $50 share price might be the one to actually perform better in context.

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2. Marijuana Investing: Keep an Eye on Share-Based Dilution

Keep in mind that in this early stage of cannabis legalization in Canada, many marijuana companies are raising capital by issuing shares or convertible debt offerings. Some, of course, have access to financing via banks or investments, but many are scrambling to get capital by any means necessary in order to grow operations.

The marijuana industry is showing "needs" that form a rather complex financial web. Because when dealing with this industry, we are considering expansion into overseas markets, brand and product diversity, and expansions at home to simply keep up with "production capacity." All the needs associated with a successful marijuana venture are costly, and funding these has to come from somewhere.

So, as alluded, many companies are issuing more shares or convertible debt offerings to raise capital. Investors must stay vigilant about this.

This is because, effectively, when a company increases its outstanding share count, it has a negative impact on existing investors. It dilutes the value of the current shares and is likely to weigh down earnings per share if a company is profitable.

Aurora Cannabis (TSX:ACB) (NYSE:ACB) is an example to note. The company made 15 acquisitions in less than three years and funded them by issuing more common stock. Now, its share count has grown from 16 million to over 1 billion. The Motley Fool says further:

"Not surprisingly, as the company's market cap has nearly tripled since the beginning of 2018, its share price has declined. Dilution may be necessary in the early going, but it's an unmistakable evil for investors."

3. Marijuana Investing: Production is Important but is Not Everything

Production capacity has become a locker-room conversation of sorts; the who's who of cannabis depends on who is producing the most. But while production capacity is important, it is often not the marker of a great investment.

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In fact, at this early stage of the industry, it's still hard to tell how important production capacity really is as, for one thing, Canadian sales have not been as strong as expected.

For example, Canopy Growth Corp (TSX:WEED) (NYSE:CGC) is expected to be the second-largest grower by peak annual output. Forecasts suggest it will be able to produce between 500,000 kilos and 550,000 kilos annually.

However, that means nothing to investors if it doesn't result in profit. And at present, Canopy, for all its size, is losing money in its operations. Analyst Sean Williams states that "Wall Street's consensus currently calls for a steep operating loss in 2019 and another substantial operating loss in 2020."

For any holders of Canopy stock, there is likely a long wait ahead before profits are returned.

On the flip side, much smaller producers such as OrganiGram Holdings may return profits much faster because it all depends on how much money a company is spending on production versus what percentage of the sales will end up in investors' pockets and not repaying debt.

Again, marijuana investing is all about context, so assuming marijuana production is everything is one sure way to get into trouble.

Before You Go

The marijuana industry is growing rapidly, and there are a host of options to choose from. Always be diligent in making your decision and remember, context is everything. Weigh up a suitor against similarly sized competitors, look for production capacity to be strong but be aware of the cost already spent to get there, and, lastly, look at stock dilution and see if it has already happened or is likely to happen again soon.

There are many factors that will affect great marijuana investing, so go in with all areas covered!

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