Strong opinions within a society can change in just a couple of generations. Cannabis is one such example of this phenomenon. Until 2000, less than 30% of Americans approved of its legalization for recreational use. Today, two-thirds of the country is in support.
So it’s not surprising that laws and regulations surrounding cannabis are also changing. In the US, marijuana is now available in 36 states for medicinal use and recreational use in 17 states. Given cannabis’ increased acceptance and use especially among young people, it’s likely to be legalized federally in the not-too-distant future. This would be a major development, as it would allow the industry to more easily access financial services to enable its growth.
Currently, the global cannabis industry is estimated to be worth $24.6 billion and expand at a 14.3% rate through 2028. This type of growth clearly entails opportunities for investors in high-quality companies. This report will give a broad overview of the cannabis industry and then highlight some of the most interesting companies in the sector: Green Thumb Industries (GBTIF), Tilray (TLRY), GrowGeneration (GRWG), Aurora Cannabis (ACB), and NewAge Beverages (NBEV).
Rising Public Support Leading to Policy Changes
According to Gallup polling, 12% of Americans supported the legalization of marijuana in 1971. Today, that figure is at 66%, having risen 30% between 2005 and 2018. Further, even among those that don’t support legalization, 75% are open to its legalization for medicinal purposes.
In large part, this sudden shift is due to younger people having a much more lax attitude towards cannabis. For people between 18 and 29, 70% are in favor of legalizing recreational marijuana. This demographic factor is important, as it means that future administrations and legislators are likely to even be more supportive as Millennials and Generation Z increasingly take these roles.
Laws are already changing. The recreational use of marijuana has been legalized in 17 states and is expected to be on the ballot for 9 more states in the next four years. Medicinal use is legal in 36 states. Only 8% of the country is opposed to the use of marijuana for medicinal purposes
Of course, a major hurdle remains in terms of its legalization at the federal level. On this front, the Biden Administration has disappointed those who were expecting swift action with Democrats also controlling the House and Senate. This has become an area of disagreement between the legislative and executive branches.
Senate Majority Leader Chuck Schumer is an outspoken proponent of legalization. In comments on the Senate floor last week, he stated his intention to push the matter aggressively in the next legislative session even if they “have to go it alone”. Currently, there are three bills with varying levels of support – one to decriminalize marijuana; comprehensive reform; and the SAFE banking act which would allow banks to do business with cannabis companies.
Growth in Cannabis Sales
While legalization at the federal level is the next looming catalyst for the industry, an equally important metric is total sales in the important North American and European markets. Sales are typically divided between medicinal and recreational segments.
However, many believe that the market size could become much bigger, as serious research on cannabis’ medical applications is in its infancy. There’s also the burgeoning CBD (short for cannabidiol) industry which is a non-psychoactive chemical compound found in marijuana.
So far, cannabis and CBDs have been shown effective in decreasing inflammation, pain, and epileptic seizures with less harmful side effects than traditional treatments. It has also been shown to help reduce nausea and increase appetite for cancer patients.
In terms of approved treatments, Dronabinol and Nabilone are two cannabis-derived treatments to treat nausea and vomiting for patients undergoing chemotherapy. They are also used to increase appetite for AIDS patients suffering from excess weight loss. Sativex is a cannabis-based nasal spray that is used to muscle-control problems for MS patients.
Many believe that cannabis can be useful in treating addiction and mental illness as well. There are ongoing clinical trials for cannabis-derived treatments targeting these areas that have the potential to be quite impactful. Another positive sign is that in states that legalized recreational marijuana, there tends to be a statistically significant decrease in opioid overdoses.
In terms of future areas of interest, there is optimism that cannabis can deliver relief for Parkinson’s disease, treat and prevent glaucoma, slow the progression of Alzheimer’s, and reduce the growth and spread of cancer cells.
In 2020, the global market for recreational marijuana was estimated to be $20.5 billion. This market is expected to grow to $90.4 billion by 2026, expanding at a CAGR of 28%.
Continued legalization is the main driver of the growth of recreational cannabis. Additionally, based on trends within younger age groups, it’s likely to continue growing more popular, while alcohol and tobacco become less popular.
In the US, 16% of adults report using recreational marijuana. As of 2020, there were $4.5 billion in legal sales with estimates of another $15 billion in illegal sales.
About 15% of Canadians report using recreational marijuana, totaling $8 billion in legal sales. Notably, Canada legalized recreational marijuana in 2018. This was followed by many non-users trying it for the first time, and legal sales starting to cannibalize the black market. This gives us an idea of what will happen in the US when it is legalized at the federal level.
The other major market for cannabis is in Europe, where there are an estimated 140 million users. Many countries have decriminalized marijuana but the vast majority of sales continue to take place on the black market. Currently, there doesn’t seem to be the same appetite to push for legalization as in North America.
In terms of the rest of the world, mass legalization isn’t expected anytime soon. Governments and the majority of populations are still opposed to it. In many South American and Asian countries, there are strict laws and penalties against its cultivation and distribution. This is certainly a headwind for the industry, but it’s also possible that their attitudes could evolve just like it has in the US and Canada over the last 50 years.
Opportunities and Risks
Clearly, the cannabis industry is growing rapidly and this presents several different types of opportunities for investors. The most obvious strategy for investors is to invest in the companies that will be growing and cultivating cannabis. These companies will benefit from growing demand especially due to the numerous applications for cannabis in terms of medicine, CBDs, edibles, infused beverages, oils, etc.
The drawback to that strategy is that these companies have little pricing power. And, it turns out there are few barriers to entry, which means that margins remain tight. Further, prices have continually trended lower over the last decade despite increasing demand due to increased efficiencies.
Another approach is to invest in the companies that are turning cannabis into products such as medicine or infused beverages. These products tend to have more pricing power and higher margins. They are also beneficiaries of the decline in the price of cannabis.
The risks of this approach are that the market is currently fragmented especially as regulations differ on a state by state basis for consumer products. There’s likely to be intense competition as well given that the market is in its infancy. In terms of investing in companies on the medical side, there’s the challenge of figuring out which companies’ treatments will be successful and receive FDA approval. Therefore, this approach is appropriate for investors who are confident that they will be able to pick the winners in these categories.
The final approach is to invest in the supply chain of this industry. These include the companies that sell inputs for production or are enabling distribution. Various examples include companies selling growing equipment, leasing real estate to growers, providing financial services, and building IT systems to manage these businesses.
Cannabis’ Bull Market
Clearly, cannabis is an enticing area for growth investors. And, it was one of the strongest-performing industries of the market from March 2020 to its high in mid-February 2021. Over this timeframe, the ETFMG Alternative Harvest ETF (MJ) climbed more than 300%.
Much of this impressive rally in the cannabis industry was due to President Biden’s victory in November, and the Democrats winning both Senate seats in Georgia’s run-off elections. With the Democrats gaining control of much of the government it was hoped that federal legalization was imminent.
However, there has been less progress on this front than anticipated, especially as some centrist Democrats and members of the Administration remain opposed. This has resulted in steep losses for many stocks in the sector and the ETFMG Alternative Harvest ETF (MJ) has dropped by 38% since its mid-February peak.
Stocks to Invest In
Although there are many interesting companies in this space, below we will analyze some of the most intriguing ones.
Green Thumb Industries (OTC: GTBIF)
GTBIF sells various cannabis products for recreational and medical use including concentrates, edibles, topicals, and packaged products that are sold in 12 states. The company also owns and operates 55 retail locations. It produces several well-known brands such as Dogwalkers, The Feel Collection, Incredibles, and Dr. Solomon’s.
Like most cannabis stocks, GTBIF experienced a massive rally in 2020 with a 166% gain. Following the Democrats winning both Senate runoffs in Georgia, shares tacked on another 65% in the ensuing weeks. Since then, cannabis stocks have sold off, along with many growth stocks. As a result, GTBIF is down 24% since early February.
GTBIF is one of the early leaders in creating national cannabis brands with customer loyalty and pricing power. The strategy is working as revenues have increased from $21 million in 2017 to $746 million in 2020. In 2019, GTBIF posted a loss of $75 million but was able to make a profit in 2020 of $25 million.
While there’s a lot to like about GTBIF, there are some risks. The major one is that it faces intense competition given the numerous private companies and startups in the private label space which could undermine its attempts to gain pricing power. Further, the company has drawn attention from federal regulators on allegations of “pay for play”.
This mixed picture is reflected in the POWR Ratings which rates the stock a C, translating to a Neutral rating. The POWR Ratings is a quantitative tool to help you find the best opportunities in the market. Since 2000, A-rated stocks have posted an annual performance of 30.7%, and B-rated stocks have posted an annual performance of 19.7%. In contrast, the S&P 500 has delivered an annual performance of 7.3%.
The POWR Ratings further evaluate stocks by various components to give investors a full picture of each stock. Thus, it’s not surprising that GTBIF is rated a B for Growth given its above-average revenue and earnings growth.
To see more of GTBIF’s component grades, including Value, Momentum, Sentiment, Stability, Quality, and Industry, please click here.
TLRY is one of the world’s leading cultivators and distributors of recreational and medical cannabis. It operates in the US, Canada, UK, Argentina, Australia, Germany, Israel, Switzerland, and Chile.
The company has recently been in the news as it’s attempting a merger with Aphria (APHA). Both companies have similar business models, and the merger is expected to result in cost savings of C$100 million. The combined entity would also be the world’s largest producer with $685 million in revenue.
However, the merger is also an indication of the challenging position for marijuana cultivators given that the market is in oversupply. Thus, many of the producers are in a difficult position. The short-term solution is to increase production to lift sagging revenues, however, in the long-term, this compounds the problem. Thus, these types of mergers between growers should be expected.
Since its February high, TLRY is down 67%. This is largely due to tough conditions for cultivators and TLRY’s high valuation. TLRY is valued at $3 billion despite only $210 million in sales. Further, its gross margin is only 11% which means that it would have to produce significantly greater quantities to be profitable.
This circumstance is reflected in the POWR Ratings which rate the stock a D, translating to a Sell rating. TLRY has an F for Stability. This is largely because the company is overvalued with a low-margin product and no easy path for growth to justify this valuation.
TLRY does have a B for Growth which makes sense considering the total market is forecast to expand at a double-digit rate over the next decade. To see more of TLRY’s component grades, including Value, Momentum, Sentiment, Industry, and Quality, please click here.
GRWG sells equipment for the growing of cannabis plants, specifically to the DIY crowd. It sells through online channels and its own retail locations. Some of the products it carries include lighting installations, organic soils, nutrients, and hydroponic equipment for indoor and outdoor growing.
Currently, the company is in the midst of an earnings growth spurt. Over the last 12 months, it generated $0.10 per share in earnings. Analysts are forecasting $0.65 per share in earnings over the next 12 months. This type of earnings growth makes it a favorite among momentum investors who believe the stock’s gains will continue.
We can get another perspective on GRWG with the POWR Ratings. The POWR Ratings are an objective tool that evaluates stocks based on 118 different factors each with its own weighting. GRWG has many intriguing elements including a B for its Growth grade. However, the stock falls short in other areas including an F for Value given its sky-high valuation.
Aurora Cannabis (ACB)
ACB is a Canadian producer of medical and recreational cannabis. Since its founding in 2013, it has rapidly grown primarily through acquisitions. Currently, it has operations in 18 countries and has a variety of products including Aurora, Aurora Drift, AltaVie, Cannimed, Whistler, and Reliva CBD.
Like a lot of cannabis stocks, ACB was a victim of the selloff in growth stocks. From its February high, the stock is down by more than 50%. The company faces similar challenges as TLRY in terms of having no easy path to profitability. It has a valuation of $1.7 billion and sales of $285 million. Unlike many high valuation stocks, it doesn’t have a high-margin product and revenue growth is slowing.
Given this state of affairs, it’s not surprising that ACB is rated a D by the POWR Ratings which translates to a Sell. D-rated stocks have an average annual performance of -2.3%. ACB does score well on Growth metrics given that its revenue has increased from $90 million to over $200 million over the last 3 years.
The company also has a Value rating of D. This is due to ACB being years away from becoming profitable, having a weak moat, and high multiples relative to its margins.
New Age Beverages (NBEV)
NBEV is based in Denver, CO. It produces high-end beverages for wellness such as dietary supplements and meal replacement shakes. However, the company has entered the cannabis space with a new line of CBD-infused beverages.
Currently, the company’s products are sold in 75 countries in retail outlets and online channels. Its CBD beverages have proven to be a hit, and the company has increased its offerings with creams, oil, and lotions. It also struck an agreement with the family of reggae icon Bob Marley for a branded line of products.
Over the last 3 years, NBEV has grown rapidly from $5 million in sales to $280 million. It seems to be rounding the corner in terms of earnings as well with the company forecasting $0.15 per share in earnings for 2021, a stark improvement from last year’s loss of $0.42 per share. At its current valuation, this would give it a forward PE of 14.9.
The POWR Ratings rate NBEV a C which translates to a Neutral rating. While NBEV does have impressive growth and a popular product, it’s still a difficult task for small beverage companies to compete with larger ones especially in terms of getting shelf space and getting the product in front of new, prospective buyers. Therefore, the company has a D for Stability as most small beverage companies have historically failed at this task. However, NBEV does have a B for Growth as it’s surpassed expectations by growing sales 40-fold over the last 3 years.
To see more of NBEV’s component grades including Value, Momentum, Sentiment, Quality, and Industry, please click here.
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This article was written by Jaimini Desai, Chief Growth Strategist for StockNews.com. Jaimini has been dialed into the hottest trends in investing:
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GRWG shares fell $43.60 (-100.00%) in premarket trading Monday. Year-to-date, GRWG has gained 9.40%, versus a 12.41% rise in the benchmark S&P 500 index during the same period.
About the Author: Jaimini Desai
Jaimini Desai has been a financial writer and reporter for nearly a decade. His goal is to help readers identify risks and opportunities in the markets. He is the Chief Growth Strategist for StockNews.com and the editor of POWR Growth newsletter. Learn more about Jaimini’s background, along with links to his most recent articles. More...
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