Cannabis: a pipe dream?

Canada | After the hype came the fall. Shares in Canadian cannabis companies have been on a tumultuous ride as of late. Since peaking in the days before the country’s legalisation of cannabis (17 October 2018), there has been a near-steady decline in many a company’s stock price.

Canadian cannabis companies, such as Canopy Growth, Tilray, Aurora and Cronos, were not well known among investors at the beginning of 2018, but by October their stocks were flying high. Many investors had piled into them, probably hoping that all those heady market forecasts will become reality. According to the London-based economic think-tank, the Adam Smith Institute, the global market for medicinal cannabis alone is expected to be worth about USD 50 billion by 2025.

Along with the legalisation of recreational cannabis in Canada, investment was being driven by increasing interest in the potential US market. Estimates say that recreational cannabis in the US could be worth USD 11 billion in 2025. Already nearly a dozen US states have legalised dope for recreational purposes. But despite the states’ push towards decriminalisation, cannabis remains illegal under federal US law.

There is no shortage of reasons for Wall Street to be sceptical of pot stocks. One is to do with the classification of cannabis stocks. Investors are divided over whether the cannabis firms should be lumped into the so-called “sin industries”, which include cigarettes and alcohol, or whether they are closer to the healthcare industry – an major issue for socially responsible investors.

Most importantly, though, the lion’s share of listed cannabis companies are unprofitable, and will remain in the red for a while. Despite this, they are hugely overvalued. Canopy Growth, in which Constellation Brands owns a stake, traded at 98 times sales at the end of 2018. Compare that with other “sin stocks”: AB-InBev, Altria, and Constellation have price-to-sales ratios of 2.9, 4.1 and 5.1, respectively. There are now 12 listed cannabis firms with a market capitalisation of at least USD 1 billion.

In the end, common wisdom will prevail. Some investors will make millions of dollars in marijuana, but many more will lose a lot of money.