This article is the sixth in a series called, “So you want to start a canna biz?” created in partnership with Good Tree Capital. This article highlights different areas you can begin with cannabis investments and should not be considered investment advice.
The legal cannabis industry has taken root in our economy and throughout our daily lives. Two out of three Americans are now in favor of legalization. And even those who don’t consume have probably run into a cannabis headline in their mainstream media.
While most industries were completely upended during the COVID-19 pandemic, cannabis proved to be essential, adaptable, and deeply rooted in our culture and economy. Reported cannabis sales increased 46% in 2020 alone, and as legalization continues nationwide more and more opportunities to invest are sprouting up.
You should do your homework before you enter into the world of cannabis stocks. This includes understanding the different types of cannabis businesses and the reality that the weed industry can be a playground for predatory practice.
Now that you’ve got your wits about you, here are 5 simple tips for investing in cannabis.
Editor’s note: The information in this article is only for educational purposes, based on the expertise of Good Tree Capital.
1. Buy organic
It’s important to remember that stock prices can fluctuate quickly due to new circumstances and the choices of influential market players.
An approach to finding great cannabis companies is to identify the small-to-midsize local operators who place more emphasis on organic growth. These cannabis operators are growing because customers demand their products, not because they’re on a buying spree to gobble up licenses.
They have positive unit economics, best-in-class asset utilization, and acquire new licenses both strategically and at a deliberate pace. Importantly, they have an exceptionally hard time accessing capital, creating a high and unmet demand.
2. Roll up your risk with ETFs
ETFs are great ways to align multiple companies with a common interest, as long as you’re diligent about the fees. They vary and can significantly erode long-term gains.
Exchange-Traded Funds (ETFs) can let investors insulate themselves from the inherent risks of any single firm or large MSO (Multi-State Operators). Cannabis ETFs are typically a basket of many companies across the cannabis supply chain, but they can sometimes include non-cannabis industry companies.
ETFs have many different mandates. Some focus on a particular segment of business, like MSOS. Others like CNBS and YOLO take a broader view. That means they often stand to gain from booms in the cannabis market while still being resilient to dramatic dips in the industry.
The quality of any ETF is only as good as the theory and practice it uses to roll companies up. They may be outperforming the market today, but whether they have a smart and compelling basis for adding/removing assets is what will determine long-term performance of any ETF.
3. Break down the research
From the seed to the sale, all good investors should roll up their sleeves and dig into the fundamentals of the businesses they invest in. The more you know about a firm or industry, the better you will be at identifying opportunities and risks in the market.
When it comes to cannabis, take the time to get to know the smaller operators running local businesses. It will certainly be more effort, but there is a lot of value being created and sustained by cannabis businesses of all sizes, including mom and pop shops.
Bad cannabis stocks will be incapable of selling their products at a price that is higher than what it costs them to bring those products to market. These company’s earnings before interest, taxes, depreciation, and amortization (EBITDA) is negative year after year, signaling that management hasn’t figured out how to keep the lights on purely with funds generated by the business.
Of course, some investors are willing to accept massive short-term losses if there is a reasonable expectation of long-term profits. There are CEOs that will justify losses as the necessary cost of rapid expansion and new license acquisition. However, a deep dive into these companies’ asset utilization often tells a different story.
Never stop doing your homework on your assets.
Follow the news to understand how acquisitions and innovations will affect cost and operating efficiencies across the entire organization. Make sure the return on assets and return on equity are not negative across the board for an extended period to avoid companies that are really just eating up investor capital without adding anything of value to the marketplace.
To measure if a potential stock is fairly priced, divide the enterprise value by sales and write down the multiple you get. A useful rule of thumb is that companies whose multiple is between 1 and 3 are probably a good value.
Generally speaking, if the ratio is low, then the company may be undervalued. If it’s high, then it means investors have to pay more for every $1 of sales generated.
4. Only invest what you can afford
Don’t get pressured by FOMO or greed to burn more green than you can afford to lose. Investing is not about finding guaranteed gains as much as it’s about balancing risk and reward over time.
Some investors prefer high-risk, high-reward assets, while others are fine with a slow and steady return they can count on for a long time. It might be a good idea to keep your stocks somewhat diverse to protect you from the highs and lows of this young and volatile market.
Just don’t forget to balance what might be a cannabis risk in your portfolio with other investments that might be more stable, like local grow operations or ancillary cannabis businesses.
If you think that one sleeper stock is gonna hit like an edible in 2023, put yourself in a position to confidently take the risk and wait out your sweet reward.
5. Invest with Good Tree Capital
Good Tree Capital avoids equity entirely. Why?
Investing in debt for the cannabis industry is a far less explored investment opportunity. Banks (by far the largest source of debt) are currently sidelined from use in the cannabis industry, which means there are hardly any small business loans available for cannabis entrepreneurs.
Good Tree Capital is solving this problem and delivering investors exceptional returns in the process.
In 2019, Good Tree Capital hosted a Hack-a-thon for small business owners and saw the impact of this form of hands-on engagement and local investment firsthand. One participant, Torica Clegg, did not see the possibility of applying for and acquiring a license without the investment in technical resources provided by Good Tree Capital.
If necessity is the mother of innovation, entrepreneurs like Torica are going to be scrappy about how they use hard-to-come-by invested funds and generate better returns for the investor in the process.