Pot Stocks Are Flying High. Here Are 4 on Firm Footing. – Barron’s

Peter Kim/Dreamstime.com

“Got high on weed stonks and forgot to sell the top,” wrote one of the asset allocators at WallStreetBets on Thursday evening. A screenshot of a Robinhood account showed just over $500,000 turning into $203,000 in a day. On the Reddit day-trading forum, this is known as posting loss porn, and it’s part of the social experience.

This particular exhibitionist “still made money cause i was in early”—which seems plausible, considering the highs reached by cannabis shares just before the smoke out.

Canopy Growth (ticker: CGC), an industry blue chip, ended Thursday down 22% for the day, but up 135% over six months. Tilray (TLRY), another biggie, was down 50% and yet up 366% for the same period.

You would think Dan Ahrens would be loving this. He picks pot stocks for the $469 million AdvisorShares Pure Cannabis exchange-traded fund (YOLO), which is up 148% in a year. In September, his firm launched a domestic sibling, AdvisorShares Pure US Cannabis (MSOS), with just $2.5 million. It’s now up to nearly $1 billion. The funds charge 0.75% and 0.74%, respectively.

The trouble is, cannabis hot money is making a hash of fundamental analysis. Last year, Ahrens bet that companies with solid cash flows, or at least healthy growth prospects and balance sheets, would rise above the rest. He also heavily favored the U.S., which is years behind Canada on legalization, but which Ahrens describes as offering a cannabis opportunity akin to investing in alcohol just after the fall of prohibition nearly a century ago.

Those bets paid off, with the older AdvisorShares fund returning 47% in 2020, even though ETFMG Alternative Harvest (MJ), a $2 billion index fund, lost 11%. Stock-picking is better than indexing when it comes to cannabis, Ahrens says. But so far this year, Ahrens is up only 58%, putting him 16 points behind the index fund.

“Companies with the worst financials—some of the companies that had been down the most in the last couple of years—are maybe trading up the most right now on hype, on Reddit, on chat rooms, on WallStreetBets, and even short squeezes,” Ahrens says. He has seen this before, although not as extreme, when Canada legalized marijuana use in 2018, and shares popped. “And then when actual results started coming in a year later, everything really crashed and burned, because those prices were based on hype.”

Canada’s head start on OK’ing pot helps explain why the best-known names, like Canopy and Tilray, are based there, and why even U.S. players have their main stock listings in Canada, and trade over-the-counter at home. Yet the grass opportunity is suddenly greener south of the border.

Colorado topped $2 billion in marijuana sales through state dispensaries last year, putting it on par with Canada, and raising $387 million in taxes and fees. In New Jersey, a state that doesn’t allow residents to pump their own gas, voters approved a constitutional amendment to legalize recreational pot—presumably, residents will be permitted to roll their own joints. Arizona, which turned blue this past election, voted to light up, too. Sure, those liberals and their reefer views—but then, how to explain red Montana and South Dakota giving the thumbs-up, too?

Virginia legalization appears imminent, which will bring the number of recreational pot states to 16. New York could be next—I’m a quarter-century out of practice, and hoping I can find my hacky sack and Dave Matthews Band CDs in time.

Just as lucrative as state by state approval would be a new federal framework. The SAFE Banking Act, stalled for two years but perhaps in play this year, would open ordinary financial services to pot companies. Policy makers might also revisit Section 280E of the tax code, which prevents cannabis operators from taking certain common tax deductions, crimping profitability.

Deal-making is heating up. Earlier this month, Jazz Pharmaceuticals (JAZZ) said it would buy GW Pharmaceuticals (GWPH), which makes medicine from cannabis, for $7.2 billion in cash and stock—the biggest pot deal to date. The 323-year-old London Stock Exchange has approved its first cannabis listing. In the U.S., meanwhile, cannabis players can’t yet cross state lines, which means many are vertically integrated, from farms to dispensaries, and not yet as efficient as they could be.

For investors who wish to partake, Ahrens recommends what he calls the four horsemen of the U.S. industry. All have shot higher of late. Curaleaf Holdings (CURLF), valued at $11 billion, has the biggest footprint. Free cash flow is seen tripling next year, to nearly $300 million. Ahrens likes that the company has hired executives from the consumer-goods industry. Trulieve Cannabis (TCNNF), at $5.6 billion, is Florida’s weed leader. Its free cash flow is projected to more than double next year, to $163 million, and then rise another 77% in 2023. Green Thumb Industries (GTBIF), valued at $8.4 billion, and Cresco Labs (CRLBF), at $5.4 billion, are Midwest operators that could do $145 million and $170 million in free cash next year, respectively.

There is more to pot investing than growers. Among the top holdings in AdvisorShares Pure Cannabis is Innovative Industrial Properties (IIPR), a real-estate investment trust. It buys cannabis property and leases it back to the sellers, replenishing industry capital, and supplying income investors with dividends. Shares yield 2.4%. Counting price gains, they have returned nearly 800% cumulatively over the past three years.

Kindly don’t read this note on the pot-stock hubbub as a call to go all-in, or even, if you’re not already so inclined, to dabble. Personally, I’m not much of a theme investor, unless plunking savings in cheap, broad stock funds counts as a theme. I’m hoping to avoid producing loss porn. Tasteful ledger shots exposing skimpy overhead, I’m willing to consider.

email: jack.hough@barrons.com

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