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Cannabis Watch

Max A. Cherney

Unknowns abound in the new industry, but these six things are important to know about every cannabis company

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The following article is part of a package of stories that MarketWatch is publishing to mark the start of full legalization of cannabis for adult use in Canada on Wednesday.

Stocks of marijuana businesses have been on a rampage in anticipation of billions of dollars’ worth of sales and other opportunities as Canada this Wednesday becomes the first G-7 nation to legalize cannabis.

Like any hot and relatively new sector, the cannabis industry can be confusing, with high potential for scams, as the Securities and Exchange Commission has warned, so investors need to know the basics. To start with, there are a handful of large companies that actually touch the marijuana plant — an important distinction — and there are metrics that are unique to the industry that can help investors understand the underlying business.

There are six large public cannabis companies that demand attention: Aphria Inc. US:APHQF CA:APH , Aurora Cannabis Inc. US:ACBFF ACB, +1.78% , Cronos Group Inc. CRON, +1.04% CRON, +0.12% , Canopy Growth Corp. CGC, +4.11% WEED, +3.11% , GW Pharmaceuticals PLC GWPH, +9.44% and Tilray Inc. TLRY, +5.35% TLRY, +5.35% . Five are Canadian and trade on the Toronto Stock Exchange and on U.S. exchanges or on the over-the-counter market, while one is U.K.-based.

All produce thousands of kilograms of weed each quarter, which is critical, as there are dozens of smaller businesses both public and private that have yet to bring products to market. Some of those are expected to die, and some are expected to thrive.

As Canadian legalization approaches, MarketWatch is profiling each of these six companies, touching on the metrics discussed below, to give investors a clearer picture of their businesses:

We are also rounding up others that could grow to challenge these companies, and some that will offer products or services connected to marijuana that don’t involve selling weed-based products.

As with any business, the top and bottom lines are critical measures of success for cannabis companies. Of the largest five producers in Canada by market capitalization (GW Pharmaceuticals is based in the U.K.), all have made medical sales, but some are not yet profitable. With recreational pot looming, Canadian companies are making big bets to capture the estimated one billion Canadian dollars — or US$771 million — in sales that will occur through the end of the year. But they can’t stay unprofitable forever.

Beyond profit and sales, there are five other criteria that investors should watch closely when evaluating companies in the industry.

What business are they in?

Eventually, some cannabis companies will probably specialize in either medical or recreational marijuana. At the moment, for pot producers large and small in Canada, they are all medical-cannabis businesses — or not making sales at all.

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There is a sophisticated, existing system to produce and distribute medical pot throughout the country and for export. What remains to be seen after Oct. 17 is which companies will be able to succeed in the recreational market. There is no guarantee that any will become the Coca-Cola of pot, and some may remain more successful at selling medical cannabis.

Not all of the companies interested in making money from marijuana, in fact, are looking at the recreational market, and some, such as GW Pharmaceuticals, are shaping up to be something that’s more akin to a drug company than a recreational-cannabis producer.

How much cannabis are they growing and at what cost?

Every major Canadian producer breaks down in its quarterly financial statements how much pot it has actually grown and how much pot it has sold. These are critical numbers because they demonstrate that the company can grow and sell the once-illegal product.

As in the cases of most businesses, it’s important for investors to be able to determine the cost of a product versus how much it’s being sold for. There is no standard way to do so. Canadian regulators are not happy with the current level of disclosure related to per-gram costs, among other reporting issues. In a notice sent Oct. 10, the Canadian Securities Administrators said the current method that many pot producers use to calculate per-gram costs was not clear and companies need to offer more detail.

Several pot businesses use the cost-per-gram metric, but it’s not a perfect number, and it’s not always clear which inputs are included. Some companies don’t disclose the metric at all; at least one breaks it down further to “cash cost” per gram. If a company does include per-gram prices, investors should compare changes from quarter to quarter, but, since it’s not a standard number, it’s important to tread carefully when comparing companies.

For all cannabis companies, one of the most significant inputs is energy, since cannabis is an energy-intensive product that requires as much sunlight as a vineyard. Low growing costs also correlate closely with the bottom line. In a CIBC research note earlier this year, analysts were assuming a roughly 60% gross margin and assuming producers can capture about C$3.60 per gram in revenue from government buyers.

How much cannabis can companies grow?

While some major cannabis producers are already profitable businesses, the introduction of recreational cannabis is expected to shift demand from the black market into the hands of legal businesses. With CIBC predicting C$6.5 billion in retail sales by 2020, companies are likely going to be able to sell much more pot than they are currently producing, so the question is how much they are planning to produce in the future.

Most large producers disclose their square footage under cultivation, as well as how much they are licensed by the Canadian government to produce. Investors should look at how much new capacity they are building, so they can figure out at what point the company will have to use capital to expand.

What supply agreements do they have?

This is where the money is, at least for now. Cannabis companies have been signing agreements to supply marijuana, both in Canada and beyond.

Licensed weed producers are regulated by Health Canada, the federal ministry that grants the certification to grow cannabis. Canadian legislation has left the provinces to determine how pot will be distributed, however, similar to how the country handles alcohol sales.

While each province has set up the rules for cannabis sales slightly differently, the agreements the various provincial entities have struck with weed producers are critical. The information provinces offer is helpful but incomplete. They have announced supply agreements but few details about actual purchases. Some provinces and companies have released the maximum amount of cannabis under the agreement the province will buy, but there is no guarantee that number will be reached. All the provinces list the suppliers on their websites, though for international deals securities filings with SEDAR, Canada’s version of the U.S. Securities and Exchange Commission’s EDGAR regulatory filing system, is the best bet.

What neither companies nor the government know at the moment is what people around Canada will actually buy, which products will be successful, or which brands will attract consumers. While every producer will make money from the first round of sales to various provincial authorities, in the long run nobody knows who will succeed.

Beyond domestic sales in Canada, there are an increasing number of opportunities to export cannabis or set up shop inside countries that have legalized medical marijuana. Most major Canadian companies have some overseas interests, whether they be supply agreements or growing facilities, especially in large, sophisticated medical markets such as Germany’s. Deals with international pharmaceutical companies for distribution are also worth noting.

What intellectual property do they own?

Canada’s medical-marijuana system has existed for years, but adult recreational use has spurred something of an arms race to develop and patent new ways of growing, refining and processing the plant. Some companies disclose their number of patents, and some don’t, but companies with intellectual property that other companies will want to license should see a boost in their valuations.

The key, as in other sectors, is that investors should look for companies that develop a technology that is best-in-class or fundamental to the future of the cannabis sector, one that competitors will have to pay to use.

5 Things Amateur Investors Say Too Often

Many seasoned investors can tell the difference between an amateur investor and a professional one just by talking to them. It’s the language that matters. The following are some common investing statements that you should try to avoid using, as well as some helpful alternatives that will not only make you sound more knowledgeable and wise when discussing the markets but should also help you think more like a professional investor.

Statement No. 1: My investment in Company X is a sure thing

Misconception: If a company is hot, you’ll definitely see great returns by investing in it.

Explanation: No investment is a sure thing. Any company can hide serious problems from its investors. Many big-name companies—like Enron in 2001 and WorldCom in 2002—experienced sudden falls. Even the most financially sound company with the best management can be struck by an uncontrollable disaster or a major change in the marketplace, such as a new competitor or a change in technology.

Key Takeaways

  • Seasoned investors can often distinguish between professional and amateur investors just by talking to them.
  • No investment is a sure thing and experienced investors understand this.
  • Sometimes the best bargains are made when stocks are tanking.
  • Costs like fees and commissions can add up and eat away at returns.
  • Sometimes passive investing, which minimizes fees, is the best approach.
  • Diversification is a wise strategy, as an individual’s investments are spread across different assets like stocks, bonds, metals, and energy.

Furthermore, if you buy a stock when it’s hot, it might already be overvalued, which makes it harder to get a good return. One strategy to protect yourself from the disaster of one or to companies is to diversify your investments. This is particularly important if you choose to invest in individual stocks instead of, or in addition to, already-diversified mutual funds. To further improve your returns and reduce your risk when investing in individual stocks, learn how to identify companies that may not be glamorous, but offer long-term value.

An experienced investor would say: “I’m willing to bet that my investment in Company X will do great, but to be on the safe side, I’ve only invested 5% of my savings into it.”

Statement No. 2: I would never buy stocks now because the market is doing terribly

Misconception: It’s not a good idea to invest in something that is currently declining in price.

Explanation: If the stocks you’re purchasing still have stable fundamentals, the lower prices might only reflect short-term investor fear. In this case, look at the stocks you’re interested in as if they’re on sale. Take advantage of their temporarily lower prices and buy up.

However, do your due diligence first to find out why a stock’s price is driven down. Make sure it is just market doldrums and not a serious problem. Remember that the stock market is cyclical and just because most people are panic selling doesn’t mean you should too.

An experienced investor would say: “I’m getting great deals on stocks right now since the market is tanking. I’m going to love myself for this in a few years when things have turned around and stock prices have rebounded.”

Statement No. 3: I just hired a great new broker, and I’m sure to beat the market

Misconception: Actively managed investments do better than passively managed investments.

Explanation: Actively managed portfolios tend to underperform the market for several reasons.

Here are three important ones:

1. Many online discount brokerage companies charge a fee of at least $5 per trade and that is with you doing the work yourself. If you hire a broker or advisor to do the work for you, your fees can be significantly higher and may also include advisory fees. These costs add up over time, eating into your returns.

2. There is a risk that your broker will mismanage your portfolio. Brokers can pad their own pockets by engaging in excessive trading to increase commissions or choosing investments that aren’t appropriate for your goals just to receive a company incentive or bonus.

Investors should pay attention to the fiduciary rule introduced by the Department of Labor, which requires advisors to disclose commissions and eliminate any possible conflicts of interest.

3. The odds are slim that you can find a broker who can actually beat the market consistently. In other words, you might want to keep track of the broker or advisor’s performance over time to determine if the added costs and fees are justified.

Or, instead of hiring a broker who, because of the way the business is structured, may make decisions that aren’t in your best interests, go ahead and hire a fee-only financial planner. These planners don’t make any money off of your investment decisions; they only receive an hourly fee for their expert advice.

An experienced investor would say: “Now that I’ve hired a fee-only financial planner, my net worth will increase since I’ll have an unbiased professional helping me make sound investment decisions.”

Statement No. 4: My investments are well-diversified because I own a mutual fund that tracks the S&P 500

Misconception: Investing in many stocks makes you well-diversified.

Explanation: This isn’t a bad start, as owning shares of 500 stocks is better than owning just a few. However, to have a truly diversified portfolio, you’ll want to branch out into other asset classes like bonds, metals, energy, money market funds, international stock mutual funds, or exchange traded funds (ETF). In addition, since large-cap stocks dominate the S&P 500, you can diversify even further and potentially boost your overall returns by investing in a small-cap index fund or ETF.

An experienced investor would say: “I’ve diversified the stock component of my portfolio by buying an index fund that tracks the S&P 500, but that’s just one component of my portfolio.”

Statement No. 5: I made $1,000 in the stock market today

Misconception: You make money when your investments go up in value and you lose money when they go down.

Explanation: If your profit is only on paper, you have not gained any money. Nothing is set in stone until you actually sell. That’s yet another reason why you don’t need to worry too much about cyclical declines in the stock market because, if you hang onto your investments, there’s a very good chance that they increase in value. If you are a long-term investor, you’ll have plenty of good opportunities over the years to sell at a profit.

An experienced investor would say: “The value of my portfolio went up $1,000 today. I guess it was a good day in the market, but it doesn’t really affect me, since I’m not selling anytime soon.”

The Bottom Line

Some misconceptions are so widespread that even your smartest friends and acquaintances are likely to reference at least one of them from time to time. These people may even tell you you’re wrong if you try to correct them. Of course, in the end, the most important thing when it comes to your investments isn’t looking or sounding smart, but actually being smart. Avoid making the mistakes described in these five verbal blunders and you’ll be on the right path to higher returns.

Should You Invest in Real Estate or Stocks?

The pros and cons of investing in real estate vs. stocks

Image by Ellen Lindner © The Balance 2020

When deciding whether to invest in real estate or stock, there isn’t a simple answer. Identifying the better choice depends on your personality, lifestyle preferences, comfort with risk, and more.

It also depends on timing. Very few stocks would have beat buying beachfront property in California in the 1970s using a lot of debt, then cashing in twenty years later. Virtually no real estate could have beat the returns you earned if you invested in shares of Microsoft, Apple, Amazon, or Walmart early on in the companies’ history, especially if you reinvested your dividends.

Timing is impossible to predict when making investment choices. But understanding each type of investment is key to choosing the best strategy to help your money grow and create financial security.

Real Estate vs. Stocks

When you buy shares of stock, you are buying a piece of a company. If a company has 1,000,000 shares outstanding and you own 10,000 shares, you own 1% of the company.

As the value of the company’s shares grows, the value of your stock also grows. The company’s board of directors, who are elected by stockholders just like you to watch over the management, decides how much of the profit each year gets reinvested in expansion and how much gets paid out as cash dividends.

It’s easy for stock to become over- or under-valued. Before investing, study the company as a whole, including how much of their profit is paid out as dividends. If a company is paying more than 60% of profits as dividends, they may not have enough cash flow to cover unexpected changes in the market.

When you invest in real estate, you are buying physical land or property. Some real estate costs you money every month you hold it, such as a vacant parcel of land that you pay taxes and maintenance on while waiting to sell to a developer.

Some real estate is cash-generating, such as an apartment building, rental houses, or strip mall where you pay expenses, tenants pay rent, and you keep the difference as profit.

There are benefits and drawbacks to each type of investment.

Pros and Cons of Investing in Real Estate

Is real estate the right investment for you? Understanding the pros and cons will help you decide.

5 Pros of Investing in Real Estate

  1. Comfort. Real estate is often a more comfortable investment for the lower and middle classes because they grew up exposed to it (just as the upper classes often learned about stocks, bonds, and other securities during their childhood and teenage years). It’s likely most people heard their parents talking about the importance of “owning a home.” The result is that they are more open to buying land than many other investments.
  2. Cash flow. Rent from real estate can provide steady, reliable cash flow on a month-to-month basis. Many investments only improve your cash flow in the long-term or when you sell them. 
  3. Limiting fraud. It’s more difficult to be defrauded in real estate because you can physically show up, inspect your property, run a background check on the tenants, make sure that the building is actually there before you buy it, and do repairs yourself. With stocks, you have to trust the management and the auditors.
  4. Using debt. Using leverage (debt) in real estate can be structured far more safely than using debt to buy stocks by trading on margin. 
  5. Safety. Real estate investments have traditionally been a terrific inflation hedge to protect against a loss in the purchasing power of the dollar. 

3 Cons of Investing in Real Estate

  1. Time and effort. Compared to stocks, real estate takes a lot of hands-on work. You have to deal with the midnight phone calls about exploding sewage in a bathroom, gas leaks, the possibility of getting sued for a bad plank on the porch, and more. Even if you hire a property manager to take care of your real estate investments, managing your investment will still require occasional meetings and oversight.
  2. Continued costs. Real estate can cost you money every month if the property is unoccupied. You still have to pay taxes, maintenance, utilities, insurance, and more. If you find yourself with a higher-than-usual vacancy rate due to factors beyond your control, you could actually end up losing money every month.
  3. Value. With a few exceptions, the actual value of real estate hardly ever increases in inflation-adjusted terms.

Even if the actual value doesn’t increase, though, you benefit from the power of leverage. That is, imagine you buy a $300,000 property, putting down $60,000 of your own money. If inflation goes up 3%, then the house would go up to $309,000 in value. Your actual “value” of the house hasn’t changed, just the number of dollars it takes to buy it. Because you only invested $60,000, however, that represents a return of $9,000 on $60,000: a 15% return. Factoring out the 3% inflation, that’s 12% in real gains before the costs of owning the property. That is what makes real estate so attractive.

Most people are more familiar with real estate as an investment than with stocks.

Provides month-to-month cash flow if you rent it out.

It’s easier to avoid fraud with real estate.

Debt (leverage) is safer with real estate than stocks.

Real estate has historically served as an effective inflation hedge.

Much more work as an investment than stocks.

Can cost you money out of pocket each month if your property’s unoccupied.

The increase in real estate value, in actuality, doesn’t increase much when factoring in the inflation rate.

Pros and Cons of Investing in Stocks

Like real estate, investing in the stock market comes with both advantages and drawbacks.

6 Pros of Investing in Stocks

  1. Longevity. More than 100 years of research have proven that despite all of the crashes, buying stocks, reinvesting the dividends, and holding them for long periods of time has been the greatest wealth creator in history.   Nothing, in terms of other asset classes, beats business ownership—and when you buy a stock, you are buying a piece of a business.
  2. Minimal work. Unlike running a small business, owning part of a business through shares of stock doesn’t require any work on your part (other than researching each company to determine if it is a sound investment). You benefit from the company’s results but don’t have to show up to work.
  3. Dividends. High-quality stocks not only increase their profits year after year, but they increase their cash dividends as well. This means that you will receive bigger checks in the mail as the company’s earnings grow. And if you hold onto your stocks long-term and reinvest your dividends, after a few decades your wealth will have grown significantly.
  4. Access. You don’t need to have huge sums of available cash to begin investing in the stock market. With some mutual funds or individual stocks, you can invest as little as $100 per month.   There are also a variety of microsaving apps that allow you to begin investing for less than $25.     Real estate requires substantially more money in your initial investment, as well as the cost of maintenance and improvements.
  5. Liquidity. Stocks are far more liquid than real estate investments.   During regular market hours, you can sell your entire position, many times, in a matter of seconds. You may have to list real estate for days, weeks, months, or in extreme cases, years before finding a buyer.
  6. Borrowing. Borrowing against your stocks is much easier than real estate. If your broker has approved you for margin borrowing (usually, it just requires you to fill out a form), it’s as easy as writing a check against your account. If the money isn’t in there, a debt is created against your stocks and you pay interest on it, which is typically fairly low. 

3 Cons of Investing in Stocks

  1. Emotional investing. Though stocks have been proven conclusively to generate wealth over the long run, many investors are too emotional and undisciplined to benefit fully. They end up losing money because of psychological factors. During the credit crisis of 2007-2009, well-known financial advisors were telling people to sell their stocks after the market had tanked 50%, at the very moment they should have been buying.   
  2. Short-term volatility. The price of stocks can experience extreme fluctuations in the short-term. Your $40 stock may go to $10 or to $80. If you know why you own shares of a particular company, this shouldn’t bother you in the slightest. You can use the opportunity to buy more shares if you think they are too cheap or sell shares if you think they are too expensive. And if you hold onto well-valued stocks over the long-term, these highs and lows are often smoothed out. But if you are hoping to make money quickly, the volatility in stock value can work against you.
  3. Stagnation. If you invest in companies that don’t have much room for innovation or growth, then your stocks may not look like they’ve gone anywhere for ten years or more during sideways markets.

However, this is often an illusion because charts don’t factor in the single most important long-term driver of value for investors: reinvested dividends.   If you use the cash a company sends you for owning its stock to buy more shares, over time, you should own far more shares, which entitles you to even more cash dividends over time.

Over 100 years of stock market returns history shows them to be a consistently-good wealth creator.

You can own part of a business (through stock shares) without having to do any work.

If you own shares in a company that pays dividends, your share price and your dividend amount may both grow over time.

You can diversify much easier with stocks than with real estate, especially with mutual funds.

Stock investments are very liquid so your money’s not locked up for weeks or months.

You can borrow against the value of your stocks more easily than with real estate.

Successful stock investing requires an unemotional approach, which is difficult for the majority of investors.

Stock prices can fluctuate very much in the short run, which can leave inexperienced investors worried.

Dividend-paying stocks may look like they haven’t grown in value at all during sideways market conditions.

Choosing Between Stocks vs. Real Estate

Both real estate and stocks can provide long-term financial gain, and both come with risks. When choosing the right investment strategy for you, the best way to hedge against that risk while taking advantage of the potential gains is to diversify as much as you are able.

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