The recent passing of the farm bill which legalized hemp production in the United States was celebrated by marijuana companies and enthusiasts. While not federally legalizing marijuana sales in the US, it certainly clears a barrier for states interested in legalization. As with many new markets, marijuana players are small, numerous, and mostly fragmented. However there is a TON of money flowing into anything weed-related right now as many folks think marijuana may be the “next big thing.”
Three of the largest marijuana stocks — Aurora, Canopy, and Tilray — are insanely overvalued. Aurora and Tilray both have a 7-8 billion market cap and Canopy is around a 15 billion market cap. This is despite NONE of the 3 having more than $100 million in revenue. Yes, revenue, not earnings. Basically that means they will need to double sales every year for the next 4-5 years to justify today’s prices. As if that isn’t hard enough, pot stocks have a history of heavy dilution, meaning any shares you buy today will give you a lower ownership percentage in the future.
But marijuana is the next big thing, right? All the bigger players are starting to team up with multinationals and sales and profits are going to go through the roof once some pesky legal hurdles get cleared, right? Maybe. Truthfully I don’t know. What I do know is there is a major problem with the long-term economics of the marijuana industry. Let’s say that post-legalization, demand skyrockets — not necessarily a given, but I’ll concede that point. Supply is where humpty-dumpty comes crashing down.
There’s a reason marijuana is known as “weed.” It’s not exactly hard to grow and cultivation time keeps getting faster as growers continue to improve their process. Also there is little to no processing required after harvest. While that’s good for the consumer it eliminates a barrier that was the key to big tobacco’s dominance for decades. Like weed, tobacco is cheap to grow. But no one wants to smoke raw tobacco, so cigarette companies ship it to massive factories, add some awful stuff to it, roll it, and voilà — an addictive processed product they can mark up and make big profits on. Another big advantage big tobacco had was they were able to create strong moats by developing powerful brands through advertising that was everywhere. Marijuana won’t have that capability.
Marijuana may indeed end up being the “next big thing,” but there are still way too many question marks for me. It’s just very hard for me to see the long-term profit margins being there. Because of the crazy high valuations and uncertain future, it’s a pretty easy call for me to sit on the sidelines and see how the marijuana industry develops. I’m just not willing to invest my hard-earned capital in a business where there are very low barriers to entry and moats are almost non-existent.